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The Sorcerer's Apprentice
The basic error underlying the Quantity Theory of Money
(QTM) is the notion that central banks can command their newly created money
to flow to the commodity market, or any other market of their choice. This is
the pipe-dream of the Sorcerer's Apprentice. In reality, once the newly
created money is off the premises it is no longer under central bank control.
It has become a plaything in the hands of speculators. Far from being guided
by the wishful thinking of central bankers, speculators follow their own
agenda. They are motivated by profit potential as they see it emerge in
various markets. It is true that, on occasion, the commodity market is their
preferred playground and mischief to prices is the result. But it could just
as well be the stock, bond, or real estate market. It is also true that there
is a "trickle-down" effect on the commodity market as the newly
created money is spent again and again by subsequent recipients who are not
speculators. But by the time money trickles down to the commodity market
damage has already been done elsewhere. Whether peddled under the name
"monetarism" or "neoclassical economics", the QTM is
utterly inapplicable to the modern economy and cannot explain changes in the
price level. The linear relationship between the stock of money and the level
of commodity prices that may have held in more primitive societies up to
medieval times has been replaced by a highly non-linear one modulated by
speculation.
Allow me
to say here that the QTM is one of those bad ideas that will probably never
go away because of its intuitive appeal. It can be grasped even by the most
primitive intelligence not conversant with monetary economics. People not
inclined to consult the more profound works of economists who have blasted
the QTM to smithereens again and again as have, for example, J. Laurence
Laughlin of Chicago University, Edwin Kemmerer of Princeton, Walter E.Spahr of New York, not to mention Adam Smith, want
to have something they can understand even if it will, more often than not,
distort the big picture beyond recognition.
Condoning the violation of the law
This is a rejoinder to the paper of Richard H.Timberlake of the same title dated August 2005. For the
sake of argument I shall adopt Timberlake's own division of the economic
collapse into two distinct events: the 1929-1933 Great Contraction and the
1933-1941 Great Depression. They were preceeded by
the inflationary monetary regime under the domineering leadership of Benjamin
Strong, Governor of the Federal Reserve Bank of New York, between 1922 and
1928. Although Timberlake characterizes it as one animated by a high-minded
"stable price level policy," it was an unlawful regime continuously
violating the law. Strong introduced illegal "open market
operations" for the first time. He established the Open Market
Investment Committee of the New York Federal Reserve Bank in 1922 under his
own chairmanship. It conducted buying and selling, mostly buying, of Treasury
bonds for the account of the Federal Reserve Bank of New York as well as some
other Federal Reserve banks. The bonds purchased in the open market were paid
for in the form of Federal Reserve notes and deposits created out of nothing
for this specific purpose. The advent of open market operations of central
banks has changed the landscape of world finance beyond recognition. It made
official manipulation of bond and stock prices possible. It turned
traditional virtues and vices upside down: thrift into vice, sharp trade
practices into virtue.
The monetization of Treasury debt was illegal
according to the Federal Reserve Act of 1913. It was not authorized. As a
matter of fact, the use of government bonds for the purpose of backing
Federal Reserve notes and deposits was explicitly ruled out. Stiff penalties
were prescribed in case, and to the extent, the liabilities of a Federal
Reserve bank could only be balanced through its portfolio of Treasury paper.
Of course, Strong and his cohorts were aware that they were breaking the law.
They argued that this policy was not official; that it was designed to meet
an emergency; and it would be terminated as soon as the emergency has passed
and the international gold standard was made operational once more. No doubt,
this was one of those 'emergencies' that was invented to become permanent.
Strong himself was instrumental in preventing the gold standard from becoming
operational again by sterilizing gold that had come to the United States from
European belligerents in payment for war supplies. It would be closer to the
truth to say that central bankers have tasted the elixir of power, and liked
it. They have become addicted to it. Never mind that it was forbidden fruit
for them. They wanted to exhaust the entire cup. They knew that they could
manipulate Congress to legalize retroactively the power they had illegally
grabbed.
The violation of the law as a substitute for
changing it whenever its efficacy is brought into question is a serious
matter in any case. But it is especially serious and pernicious when it
affects the processes whereby money is created. Legal ends cannot justify illegal
means under the law. If an officer of the Federal Reserve can take liberties
with the law, then so can anybody else, and the bottom line is counterfeiting
the currency. Timberlake passes over the blatant violation of the law in
silence, presumably because of his sympathies with the hidden monetary
inflation that he (in unison with Milton Friedman and Anna Schwartz)
admiringly calls "the Fed's stable price-level policy". Hardly did
he notice that what he admired was not monetary policy under Strong, but a
mere coincidence: the knack of the speculators who for reasons of their own
put the newly created money to work, not in the commodity market where
inflation would have been noticed immediately, but in the real estate and the
stock markets where it could remain hidden for a longer period of time. In
the event the Strong-inflation could not be swept or kept under the rug for
too long. It soon showed up in the shape of the Florida real estate bubble
(1924) and the stock-market orgy (1929). In addition, it kept interest rates
artificially low (and bond prices artificially high) with the effect that the
investment-decisions of businessmen became distorted. Again, the concomitant
misallocation of economic resources could not be detected immediately. But
the writing was on the wall that the chickens would eventually come home to
roost, as indeed they did during the Great Depression. To sing a song of
praise of the Strong-inflation is not fitting to a monetary economist.
Condoning the violation of the law and blaming the
consequences: the Great Contraction of 1929-1933 and the Great Depression of
1933-1941 on the Real Bills Doctrine (RBD) is, to say the least, disingenious. This is not to suggest that the Federal
Reserve Act of 1913 was a good law. Most likely it was not, and the United
States could have managed, thank you very much, without a central bank in the
20th century, as it did in the 19th. But this is another issue to be
investigated separately. Here I want to condemn a procedure whereby the law
is violated in order to create a fait
accompli, forcing the hands of
lawmakers to change it so that, in the end, the violation be
justified, nay, rewarded. Once the Strong-inflation induced stock-market
speculation was under way, money from abroad was sucked in causing a serious
deflation in Europe and elsewhere. Central bankers from around the world
started making their regular pilgrimages to New York begging Strong for even
more inflation. They had hoped that lower interest rates in America would
bail them out. Strong was delighted to comply with their pleading. Thus the
violation of the law created international complications and ultimately
Congress had to amend the Federal Reserve Act of 1913 so as to legalize the
practice of open market operations -- euphemism for monetizing the the public debt. The cure for the ill effects caused by
an illegal monetary inflation was to be more monetary inflation, not less,
making sure that this time around it was fully licensed and legalized.
Today no economist would think of open market
operations as being originally conceived and introduced as an illegal
practice, or would dream of suggesting that the explanation for the Great
Contraction that followed it can be found in the violation of the law. I
hereby take the task upon myself to make this revelation. It has to be stated
in unambiguous terms that the Strong-inflation of 1922-1928 celebrated by
Irving Fisher, Milton Friedman, Anna Schwartz, Richard Timberlake, and other
devotees of the QTM, was illegal. I am of course aware that the grant
departments of the Federal Reserve banks will never support research to
explore this episode more fully to confirm my accusations. I still hope that
incorruptible economists, especially the younger generation, are motivated by
the truth rather than bribe money, and will rise to my challenge in doing the
necessary research.
Exonerating the gold standard is not enough
Following Keynes it has been fashionable to blame
"contractionist tendencies" inherent in
the gold standard for the Great Depression. Timberlake, to his credit, makes
a valiant effort to exonerate this venerable institution. As the German
monetary economist Heinrich Rittershausen said, it was not the gold standard that failed
but the people to whose care it had been entrusted. It is unfortunate
that Timberlake's concept of the gold standard is faulty. He quotes Joseph
Schumpeter approvingly who describes the international gold standard as an
institution linking the price level in one country with that in all other
countries 'on gold'.
But this is not what the gold standard does, nor is
it the way it is supposed to work. The price level is too 'sticky' for
adjustment through gold flows, however attractive the QTM model of price
adjustment may appear. Gold flows were conspicuous only through their absence
during 100 years of international gold standard ending in 1914. Furthermore,
although the gold standard had a mechanism for the equalization of the
discount rate between various countries, this did not mean an automatic
equalization of interest rates. The two rates are conceptually very
different, as are the forces governing them. They could move in the same or
in opposite directions. The adjustment mechanism of the gold standard
operates, not on the price level which is sluggish, but on the discount rate
which is nimble. It is not gold flows but the flow of real bills, and the
flow of underlying merchandise in the opposite direction, that perform the
balancing act, keeping the economy on an even keel. Here is how. Suppose
certain countries suffer from a natural disaster or experience crop failure,
causing widespread shortages. The discount rate in these countries will rise
above that prevailing abroad, making the stricken countries attractive on
which to draw bills. Consumer goods are dispatched immediately to the high
discount-rate countries from the low. Relief is instantaneous.
It was not a flow of gold but that of real bills on
London, maturing into gold in less
than 91 days, that financed world trade prior to World War I. Gold hardly
ever left the vaults of the Bank of England. Its relatively small gold
reserve could finance a world trade several times as large. Without real
bills world trade could have never expanded the way it did during this Golden
Age. By 1913 it reached a record high that could not be surpassed for the
next 75 years. Timberlake commiserates that the gold standard was in
'remission' during the years following World War I. It is true that the
garrison states that emerged after the signing of the peace treaties were
pursuing highly protectionist policies. The efficiency of gold in financing
world trade has fallen from the high level reached during the years prior to
World War I. Lip service was still being paid to gold thereafter, but the
garrison states embraced mercantilistic ideas and
they were determined to wean their subjects from the gold coin. They
foolishly concentrated gold in official coffers rather than putting it to
work in reconstruction and in refinancing world trade. They sterilized gold
by letting their central bankers sit on it. The United States was no
exception. Why should Governor Strong put excess gold reserves into
circulation in the form of gold coins? He knew that the outcome would be
losing his cherished dictatorial powers. Open market operations and gold coin
circulations are incompatible.
Gold inflation is a red herring
Of course, Strong argued that putting gold coins
into circulation would be 'inflationary'. Timberlake agrees. They are wrong.
Even if all the world's monetary gold had descended
upon the United States and were put into circulation, there would have been
no price increases. The (natural) discount rate would go to zero. As a
consequence vendors could do their 'vending' with zero capital (i.e., they
could sell first, and pay for the merchandise out of the proceeds). Marginal
merchandise would be displayed on sidewalks, public squares offering shoppers
a previously unheard-of variety of goods. The abundance of gold coins would
call out an equal abundance of consumer goods. Circulating capital would
expand, matching the increase in gold coin circulation to finance trade in
marginal merchandise. Automatically and immediately. The maxim that 'more
money chasing fewer goods brings higher prices' does not apply, provided that
the color of the money is yellow and it has the
right ring to it when plunked down on the counter. The collapsing discount
rate will see to it that a sufficient abundance and variety of goods is
always available. Prices need not rise on account of a greater abundance of
gold coins in circulation. 'Gold inflation' is a red herring.
Conversely, there would have been no deflation when
European countries recovered after the war and started repatriating their
gold. The contraction of the pool of circulating gold coins would make the
(natural) discount rate rise in the United States. Vendors of marginal
merchandise would fold tent. Circulating capital financing trade in marginal
merchandise would shrink, matching the decrease in goldcoin
circulation. The variety of goods available to consumers would be reduced
accordingly. Prices need not fall on account of a reduced abundance of gold
coins.
Discounting is not lending
It is not enough to exonerate the gold standard which
cannot be fully understood without a proper understanding of the RBD. This
Timberlake clearly does not have. In real bills he sees a 'false anchor'
competing with gold in the balance sheet of the central bank. In his view the
central bank monetizes real bills. The bill is merely a
collateral securing the loan and could be replaced by bonds that could
also be used for the same purpose. In reality they could not. Banks do not
acquire real bills in consequence of a passive
manoeuvre such as securing a loan. Just the opposite is the case: discounting
(rediscounting) real bills is an active
bank manoeuvre. The bank (central bank) takes the initiative and goes out
to acquire an earning asset. The bill is not a collateral security for a bank
loan, neither is the merchandise underlying it. The
real bill is an earning asset that is second to none in liquidity (it is
second to gold but gold is not considered an earning asset). For a commercial
bank, asset liquidity is a primary concern because in a squeeze, or to meet a
run on the bank, these assets may have to be mobilized and thrown on the
market simultaneously and indiscriminately. Even government bonds cannot come
close to real bills as far as their liquidity is concerned. If mobilized and
thrown on the secondary market in a panic (as it happened after World War I
in 1921), bond prices would collapse and interest rates would shoot up. Yes,
even for government bonds. By contrast, real bills are always in demand as
long as the underlying goods are. One-ninetieth of the portfolio of bills of
every commercial bank matures on every single day of the year. To maintain
revenues the bank has to replace them. If one bank has to sell, it will
always find another that wants to buy. Even if the taste of consumers has changed,
the short maturity of the bills, 91 days (or 13 weeks, or 3 months, or one
quarter) makes it certain that bills in disfavor
will expire and disappear quickly, long before they could cause mischief. In
the worst-scenario case, the drawer of the bill would pay it at maturity even
if he had to take a loss. He would do it lest he lose his discounting
privileges for good.
The fact that real bills are the most liquid earning
asset a bank can have, combined with the fact that the real bill 'matures'
into gold coins released by the consumer in buying the underlying good, makes
these instruments very special. In the asset pyramid they come right after
the monetary metals. It is wrong to look at real bills as competition for
gold. Real bills are supplementing gold in financing circulating capital, not
competing with it. No prior saving is necessary. It is sufficient that the
underlying merchandise be in urgent demand. On the other hand, real bills
cannot and will not finance fixed
capital. To do that you must have savings in the form of gold. People who
insist that prior savings is also a prerequisite for the financing of
circulating capital are myopic. There is no way society could save enough to
finance the entire circulating capital of a modern economy, in addition to
financing its fixed capital. A simple back-of-the-envelope calculation can
convince any open-minded observer of that. Real bills, and only them, can
make it possible that gold is not tied up unnecessarily in moving merchandise
in urgent demand to the consumer expeditiously. Gold, thus released, can then
be used to form new fixed capital in financing more roundabout processes of
production. The great improvements in the productivity of capital in the 19th
century would not have been possible without this division of labor between gold and real bills.
When a bank discounts a real bill, it is not making a loan (even though pro forma the transaction may be
dressed up as such). Rather, the bank acquires a self-liquidating paper which at maturity is paid out of the
proceeds of the sale of merchandise described on the face of the bill. The
gold coin released by the ultimate consumer liquidates the bill. Other loans
that the bank may make are not self-liquidating. In more details, at maturity
the borrower has to invade the pool of circulating gold coins and withdraw
the necessary amount. Should too many loans of this type wait in line to be
liquidated simultaneously, there would be a problem. Unless banks could make
snap loans to credit-worthy customers, there would develop a squeeze on the
money supply. Innocent third parties would find it difficult or impossible to
discharge their obligations. Defaults could cascade. This is the stuff out of
which depressions are made. This was the core problem after the stock-market
collapse in 1929 which revealed that businessmen had been misled by
artificially low interest rates. There were no profitable investments on the
horizon. There were no credit-worthy borrowers to take the loans the banks
were so desperate to make. As a result, the stock of money collapsed as a
pricked balloon, replicating the collapse of the stock market.
The case is different with self-liquidating loans.
As long as people want to be fed, clad, and sheltered in warm homes in
winter, there will always be an adequate supply of real bills, and banks may
compete for them. Nobody is squeezed and there is no threat of cascading
defaults. As I have said it is wrong to assume that the banks take the real
bill, or its underlying merchandise, as a collateral
for loan. It is wrong to say that the bank monetizes real bills. It is the market that in fact does the monetization. Discounting bills is
not a lending funcion of the bank, but a clearing
function. This was known to Adam Smith already well over two centuries ago.
He said that real bills could circulate on their own wings and under their
own steam. What the banker does is this: he goes out and buys them as the
most eligible prime earning asset he can have, one that can always be
liquidated in an emergency without fear of a loss, regardless of the vagaries
of the interest rate and the economy.
The gold standard and the RBD in the Federal Reserve
Act of 1913
Timberlake states that the idea of a central bank
was anathema to the newly elected Democratic Congress and president in 1912.
The presumption was that a central bank is monolithic and monopolistic. It
would not serve the public. Rather, it would further the interest of the
bankers. We may be well-advised to take this view of Woodrow Wilson and his
Congress with a grain of salt. True, they may not have suffered the expanded
power of the banking establishment gladly as it existed then. But this did not mean that they would not embrace unlimited
power to monetize government debt, given the opportunity to do so. In
particular, Secretary of State William Jennings Bryan was a dyed-in-the-wool
inflationist. There is a painting on display in the Treasury Building on
Pennsylvania Avenue depicting him as he gleefully signs the very first
Federal Reserve notes ready to be rushed into circulation on Christmas Eve,
1913. This Santa Claus of the century has given the world the Federal
Reserve, the income tax, no-sweat financing of wars (declared or undeclared),
in one word: unlimited power concentrated in the Washington establishment,
epitomized by the unlimited power to monetize public debt. This power was
grabbed unconstitutionally through the unlawful introduction of open market
operations less than ten years later. Even before that, the Federal Reserve
was a tool in the hands of trigger-happy politicians who faced a country with
no stomach for getting entangled in a fratricidal war on another continent an
ocean apart. The warmongers were determined to get a piece of the action by
hook or crook. For starters they were eager to finance the trade in war
material, especially as it was being dispatched to the Entente powers in
violation of the Neutrality Act. Needless to say, financing foreign wars
fought by foreigners on foreign soil for foreign interests was not the
purpose for which the Federal Reserve System had been established. But let us
not make a shortcut in relating events as they unfolded.
It is true that Congressmen who sponsored and passed
the Federal ReserveAct of 1913 sincerely believed
that the commercial banks' and the Federal Reserve banks' faithful adherence
to the RBD would make the monetary system self-regulating, so that the
involvement of the Federal Reserve as a central bank could be kept at a bare
minimum. Five years of diligent research, after the panic or 1907, had gone
into the preparation of the legislation. As mentioned by Timberlake,
prominent economists such as H. Parker Willis and Adolph C. Miller, both
former students of J.Laurence Laughlin of the
University of Chicago, played a crucial role in this research. Not mentioned
by him was Paul Warburg, an immigrant from Germany with connections to
banking circles there, who brought with him the experience and expertise of
the Reichsbank, established a few dacades earlier, after a careful study of banking
principles with characteristic German thoroughness. The law governing the
operation of the Reichsbank was animated by the
RBD. Most of its provisions were also written into the Federal Reserve Act of
1913. Carter Glass was the
Chairman of the House Banking and Currency Committee nursing the Bill that
was to become the Federal Reserve Act. As Timberlake observes, Laughlin was a
long-time opponent of the QTM. Miller, together with Willis, supported his
criticism of this simplistic theory. In Congress, Carter Glass promoted the
pro-RBD and anti-QTM ideas into law.
Hijacking of the Federal Reserve by warmongers
The Federal Reserve Act of 1913 was not a perfect
document. In many ways it was rather imperfect. It did not close loopholes
whereby real bills could be made to do overtime and consequently become stale
in the portfolio of Federal Reserve banks, that would be a drag on the
system. The distinction between real bills and accommodation or anticipation
bills was not made watertight. Above all, the very idea that the country's
gold must be entrusted to 'reserve' banks, rather than to the people
themselves by putting it into circulation, is a monstrosity. Be that as it
may, the Act had the attributes of a reasonable legislation to prevent
inflationary and deflationary adventures of an activist central bank. The
idea of linking the emergence of new currency to the emergence of goods and
services in urgent demand (and the retirement of currency at the time of the
sale of merchandise or completion of service) was sound. Resisting the
temptation to organize the public debt into currency was admirable. Under a
more favorable constellation of the stars the
experiment of founding a central bank of the people, for the people, by the
people, may have succeeded.
Unfortunately, constellation was anything but
propitious. The fledgling institution had no chance to succeed in its
mission. The Guns of August shot the gold standard, and the bill trading
supplementing it, to pieces. Enemies of private enterprise, free trade, and
the ideal that the individual knows best what is good for him, together with
collectivists of all spots and stripes, saw a great opportunity coming their
way presented by the fratricidal war overseas. The socialist minorities
sitting in European parliaments, without exception, voted all the war credits
governments asked for and then some, in effect throwing out the gold standard
as useless baggage inappropriate to carry along in wartime. In reality, the
retention of the gold standard would have greatly shortened the war. As taxes
to pay for the prolongation of war had had to be increased, the pressure on
belligerent governments to make peace would have intensified.
At least in Europe where nationalistic fervor could reach fever pitch the blind sentiment to
continue the war to total victory or death was understandable. But in the
United States the European war did not make sense to ordinary people. Their
ancestors came to this continent to escape the arbitrary war-making power of
kings. No pet wars for presidents here, they had thought. The country stayed
neutral for the first three years of the conflict, in spite of ongoing
political intrigues to take the plunge. The Constitution had assigned the
power to declare war to the House of Representatives, and congressmen would
not antagonize their pacifist constituents by war-mongering. It was in the
president's official family where warmongers found a niche and could prepare
the ground for the United States' entry to the conflagration, through
provocation if need be.
We shall never know what would have happened if two
momentous events: the eruption of war in Europe, and the Federal Reserve
banks' opening their doors for business, had not coincided in the fateful
year of 1914. One thing is certain: the world would be quite different from
what it is now.
The Great Contraction
Strong died while in office in October, 1928. The
removal of this tyrant gave a chance to his enemies to crawl out of the
woodwork. They did not delay making the system conform to RBD guidelines as
required by the Federal Reserve Act -- a most unfortunate development in the
view of Timberlake. Here is another interesting historical coincidence. Two
events: the bursting of the stock market bubble fed by the Strong-inflation,
and the death of Strong were separated by just one year. We shall never know
what would have happened if Strong had lived to continue his open market
operations in the 1930's. Timberlake says that the Great Contraction would have
been avoided. Strong would have pumped even more money into the system,
anticipating Greenspan's response to the "irrational exuberance" of
the stock market. We may agree, for the sake of argument, that this could
have postponed the crisis. Yet it is certain that the crisis caused by a
growing amount of central bank money in circulation could not be put off
forever. Timberlake's assumption is tantamount to assuming that damage caused
by inflation can be cured by more inflation ad infinitum. However, in our more sober moments we should admit
that inflation cannot survive as a permanent monetary policy. The Fed combats
falling prices by open market purchases of bonds, and it combats rising
interest rates -- you have guessed it -- by more open market purchases of
bonds. The cure is always the monetization of more government debt,
regardless whether you are combatting inflation or deflation. Just print more
money, rain or shine. We know from history how inflationary adventures
inevitably end. There could be nuances of difference, but deflation that
follows inflation as night follows day cannot be avoided, no matter how much
government debt is monetized by the central bank.
The Federal Reserve Board minus Strong had the
unenviable task to rein in the unbridled Federal Reserve credit that was
feeding the stock market orgy. They tried to do this as gingerly as they
could. Credit contraction is always painful. The pain that goes with
contracting an unprecedented credit expansion is no less unprecedented.
Timberlake is right in assuming that the Great Contraction has run its course
by 1932 and there were signs of recovery in early 1933. Why did then the
Great Depression follow so hard on the heels of the Great Contraction? Here
the use the RBD as whipping boy that can be conveniently blamed for deflation
comes handy. Timberlake does not pretend that his thesis is original. Indeed,
it is not. You could have become a Nobel prize laurate
in economics for suggesting it first. But even a dozen Nobel prizes cannot
overtake truth.
Why the Great Depression?
Although the Great Contraction in the wake of the
Strong-inflation was unavoidable, the Great Depression was not. The world was
sucked into it not because of the
RBD but in spite of it. If
Timberlake does not see it that way, it is due to his faulty understanding of
the RBD, which is inseparable from the gold standard. Real bills must mature into gold coins. Otherwise
the RBD makes no sense. Why can't a real bill mature in Federal Reserve
notes? If it could, it would not have come into existence in the first place.
An omniscient and omnipotent Fed could helicopter-drop just the right amount
of Federal Reserve notes, when needed, where needed, for the smooth
functioning of the economy. They tried that approach in Bolshevist Russia,
with results only too well-known. The experiment was discontinued in Russia's
'Evil Empire' in 1990. Now they try it again in the U.S. and its very own
Evil Empire. As Benjamin Franklin has said, experience runs an expensive
school, but fools will learn in no other.
Just as the world economy was making its first
tentative steps to recovery in 1933, the international gold standard -- and
together with it the bill market -- were mortally wounded by saboteurs. The
newly elected Democratic President, no less strong a man than Governor
Strong, took the law, and the Constitution, into his hands in March, just a
few days after inauguration. Under the threat of heavy fines and prison terms
he called in all gold coins and gold certificates by issuing a Presidential
Proclamation. Next, he cried down the value of the Federal Reserve notes in
terms of gold, the very same notes that had been paid out 'in compensation'
to holders of gold. In other words, the president used the strong arm of
government to pauperize the citizenry. Pity poor Henry VIII. He was being
mocked as "Old Coppernose". Yet the
vilest thing he ever did to the coin of the realm was to give it a gold wash.
When the wash rubbed off after a few years of wear and tear, the copper nose
on his effigy became plainly visible. Ownership of solid gold coins was not
made illegal. People who could see through the cheap trick were not harmed.
Those who were, could at least have a good laugh for
their money whenever they looked at the coin counterfeited by their
sovereign. But what this president did amounted to raping an entire nation.
People were deprived of their gold coin they needed to validate their demand
for consumer goods. Thereafter producers of goods and services would not take
orders directly from the consumer bereft of his gold coin. Instead, they
would take orders from the issuers of purchasing media, the bankers. They
were the ones to call the shots, and to pay the piper. The consumer must take
it or leave it.
Timberlake does not see this. He insists that the
'gnomes' of the Federal Reserve have smuggled real bills back into
circulation for doctrinaire reasons. Their plot could not possibly work.
Production has stopped (or nearly so) and the flow of real bills dried up,
making the economy come to a screeching halt for lack of purchasing media.
Meanwhile gold was piling up in the vaults of the Federal Reserve Bank of New
York well in excess of reserve requirements, doing nothing. Surely, a strong
leader such as Strong would have issued Federal Reserve credit against this
gold, and the Great Contraction as well as the Great Depression would have
been avoided, according to Timberlake. This betrays his incomplete
understanding of the RBD, which makes
the availability of gold coins to the consumer an absolute prerequisite.
Here is what would have happened, had the
dictatorial-minded president not confiscated gold. The RBD would have been
allowed to operate. As foreign gold flowed to the country, it would be
monetized, and the discount rate would be driven lower, perhaps all the way
to zero. The United States would have become the clearing house for real
bills originating from all over the world. The movement of goods in
international trade would have been financed by real bills drawn on New York,
just as prior to World War I world trade had been financed by real bills
drawn on London. The low discount rate would have revived the export industry
of the United States. Recovery of production for the domestic market could
have proceeded apace. The apalling unemployment
would have never happened. The Great Depression would have been avoided.
None of this was going to occur because the boat of
the international gold standard has been torpedoed and real bills, being tied
to the mother ship, went down with it.
Lionizing saboteurs
Timberlake is blaming the victim of a disaster for
the disaster caused by sabotage. The RBD could have been the savior had it not perished along with the gold standard at
the hand of collectivist assassins. Real bills could have revitalized world
trade and revived the world economy. But the lion's share of world gold had
been sequestered and made unavailable for any purpose whatever by a
megalomaniac. Bereft of its gold, the world had no choice but go through the
meat-grinder. It was no coincidence
that the beginning of the Great Depression coincided with the incarceration
of gold.
Timberlake should refrain from lionizing lesser
saboteurs such as Strong. It appears that his hero is the Latter-Day Strong
alias Alan Greenspan. Unfortunately, he says, Greenspan may have come too
late and may have left too early. The task of enforcing the "stable
price-level norms of Benjamin Strong" has remained unfinished. I quote:
"The huge unfunded liabilities of the federal government, as they come
due in coming decades, are going to require the U.S. Treasury to pay them.
The Treasury will have to 'get the money' to do so. It will 'ask' the Fed for
'help' in keeping interest rates 'down'. Whereupon the Fed, unless it has a
Chairman made of titanium steel, will buy those Treasury securities in the
open market -- yes, holding interest rates 'down' temporarily, but thereby
creating new money and initiating an ongoing central bank inflation. The
German model [of hyperinflation] of 1923 will be only too applicable."
Is this not exactly what Governor Strong, not having
a constitution 'made of titanium steel', had done and would have continued
doing had he not succumbed to tuberculosis in 1928? Can the policy of curing
the ill effects of inflation with more inflation have any other ending?
Abstract
"Federal Reserve policies were one hundred
percent responsible for the Great Contraction and the subsequent Great
Depression. The damage done both materially and ideologically was, and is,
inestimable. Ignorant govermental reactions to the
debacle resulted in vast expansions of incursions in the economy, and in a
vast expansion of powers that no Supreme Court could stop. Worse still, the
common misconception of a market system that had 'failed', resulted in a
popular ethos of anti free-market
regulation and governmental interventions that have increased exponentially
with no end, or even equilibrium, in sight."
My agreement with this assessment of Timberlake is
complete. Our difference is centered on the
question whether the follies of the Federal Reserve consisted of its abiding
by the law, or violating it. This article makes the case that violation of
the law, regardless whether you consider it good or bad, creates far greater
problems than those it may hope to solve. It also points out that gold coin
circulation is a sine qua non of
the RBD. Timberlake ignores the implications of the fact that the newly
inaugurated president confiscated the gold coins of the people on March 4,
1933. The coincidence of that day, which will 'live in infamy', with the
beginning of the Great Depression was no
coincidence.
References
Richard H.Timberlake,
Federal Reserve Follies: What Really Started the Great Depression, http://mises.org/blog/archives/timberlake.pdf,
August, 2005
Milton Friedman and Anna Schwartz, A Monetary History of the United States,
1867-1960, Princeton U.P., 1963
Bill Koures, Real Bills: an Emergent Market Phenomenon,
http://www.safehaven.com, September 26, 2005
Nelson Hultberg, Real Bills vs. Rothbard's
100 percent Gold System,
http://www.safehaven.com, September 6, 2005
July 26, 2006.
Antal E. FEKETE
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