Unanswered Questions Dept.

     Nasty habits usually come with their own punishments. My nasty habit is talking about money. Not how to make oodles of it; that’s an arcane art. At any rate, I haven’t mastered it. No, I talk about the nature of money, and why it’s no longer with us.

     I shan’t repeat the litany about the properties a medium of exchange must have to qualify as a money. If you really want to read about it, here you go. It involves an appreciation of social and commercial evolution, so if you haven’t delved into the subject before this, prepare for a fairly long course of study.

     No, today’s subject arises from a question that was asked of me just yesterday evening: Why, if the pre-1913 regime in which America’s monies were gold and silver, did “we” replace them with an unbacked fiat currency? What was the point of changing from that to the “Federal Reserve System?”

     Heh, heh, heh!

     Throughout history, governments – States – have always chafed at any restrictions their subjects have succeeded in putting on them. One of the most important such restrictions is the ability to spend only what the tax revenues provide.

     A government that seeks to expand its activities beyond what current tax revenues will support must do one of the following things:

1. Borrow;
2. Increase existing taxes;
3. Enact new taxes;
4. Create “money” from nothing.

     Methods 1, 2, and 3 have undesirable consequences. Debts must be paid, at least if the debtor hopes to borrow in the future. Any increase in taxation engenders resentment and resistance. It could lead to a change of regime. New taxes – i.e., taxes levied on things or activities that were previously untaxed – lead to changes in commerce that cannot be reliably predicted. Sometimes the things or activities newly taxed will move to a less taxed venue, decreasing rather than increasing aggregate revenue.

     But Method 4… ahhh.

     In an economy that uses gold and / or silver as its money, “creating” money is damned difficult. It involves a practice once called coin clipping. A king can only take that practice so far before people start to notice that their gold and silver coins are getting smaller. (Also, putting a reeded edge on coins helped to thwart clipping.) That can cost the king his throne… and his head. So the first thing that has to go before the State can start “creating money” is the use of the precious metals as money.

     Now, this raises a side issue about the way people buy, sell, and pay for things in their daily lives. In a completely precious-metal system, they routinely handle gold and silver coins. Those media are familiar to them; their use presents no surprises. This is clearly desirable condition… for ordinary people and commercial concerns. It’s not so desirable for the State.

     The State needs to get people unused to handling gold and silver. It must somehow divert them to another medium of exchange that will distance them from the precious metals: a medium that offers certain conveniences but is intrinsically valueless.

     The start of the evolution that follows is almost always paper currency.

     When paper currency was introduced to the “regular” (i.e., non-wartime) American economy, the notes all said something like this: “Redeemable in silver on demand.” They had to say something of that sort. To Americans, silver was money; paper was just paper. So dollar bills were regarded as another form of check or promissory note: as a promise to pay in real money.

     Today that promise is no longer honored. The mention of it has been removed from the paper notes. Even older notes, few as they are today, can no longer be redeemed for real money.

     But even paper currency has some disadvantages in hand-to-hand transactions. The foremost of them, if we omit counterfeiting and physical deterioration, is that there’s a lower bound on how small an amount of money people will accept as a paper note. So coins of sub-dollar denominations would continue to circulate. That cross-cut the government’s intentions by keeping silver in Americans’ hands and pockets.

     Before the rise of computerized banking and accounting, there wasn’t much the State could do about that. Washington reduced the silver content of the coins, eventually removing it altogether, but the coins themselves constitute a reminder. The reeded edge on a quarter has a historical significance that American schoolchildren continued to learn about. Too many questions were being asked.

     Ultimately, the emergence of a completely nonmaterial currency solved the State’s problem. Now that most payments are made electronically, Americans’ memory of physical money and currency is fading. Physical “money” – money with a substance that goes beyond a bookkeeper’s entry or an entry in a bank’s database – is fading from our economy and from Americans’ consciousness.

     I doubt I need to explain to the Gentle Readers of Liberty’s Torch how convenient this is for the State.

     Of course, the scheme had to be decorated with some institution that would give it an air of order and legitimacy. The name of that institution is the Federal Reserve System: a collection of supposedly private regional “banks” with a supreme board of governors. In theory, the Fed “manages the money supply,” so it doesn’t explode out of control. In practice, whenever the federal government goes to the Fed for money, it gets what it asks for. The Fed merely creates it on the spot. The price is only another bookkeeping entry on the Fed’s ledgers: i.e., an increase in what the federal government owes the Fed.

     Today, most federal borrowing takes place exactly that way. It’s made the purchasing power of the federal government unlimited de facto. The government’s debt is as virtual as our money has become. Little of it exists in the traditional form of Treasury bills. None of it is redeemable in gold or silver.

     There are consequences, of course. That massive federal borrowing results in a huge expansion of the “money supply.” Yes, that’s a virtual entity, but so are the savings you have at the bank. And as the “money supply” increases, the value of each dollar, measured in purchasing power, decreases.

     As the saying goes, more and more dollars are chasing a more-or-less constant supply of goods and services. The effect perceptible by ordinary Americans is general price increases: i.e., price increases in just about everything.

     But the Fed “manages” all of this. How? By changing the “prime rate:” the interest rate at which the government and member banks will borrow from it. An increase in that rate makes loans more expensive, and thus harder to afford. That doesn’t change the money supply; it merely toughens your access to credit. The government just keeps on borrowing.

     The Fed is, in the classic phrase, “lipstick on a pig.” With the federal government addicted to borrowing, all that Fed “management” can achieve is making purchases made on credit more or less expensive for you and me. The increase on the “annual interest” owed on the federal debt is next to meaningless to the government, which can always just borrow more money with which to pay it.

     Fiscally astute Gentle Readers will already realize that this is a positive-feedback cycle, and thus doomed to end with a runaway. The dollar will become worthless, unacceptable in commerce. It happened in Weimar Germany. It happened in Sun Yat-sen’s China. It happened in Peronist Argentina. And sooner or later, it will happen here.

     But until it does, the federal government can spend whatever it pleases. That greatly pleases politicians eager to buy the allegiance of important voting blocs. What makes it possible is the destruction of money as Americans had known it, starting from around 1913, and the erection of the Federal Reserve System to camouflage the process. And all that having been said, I think I’d like to lie down for a century or two.