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Fractional reserve banking emerged at about the same time as a system whereby banks were legally permitted to lend more money than they retained in deposits (regardless of whether those deposits were in the form of gold or fiat money). This process seems myste- rious and perhaps even a tad unethical to most people when they ini- tially learn of it. However, it has become the foundation of modern banking and currency systems. In effect, when a commercial bank makes a loan, it creates money from nothing. When the loan is repaid and is struck from the books, that money effectively disappears. Since it has been lent into exis- tence, virtually all fiat currency in modern money economies is tied to debt, which requires the payment of interest. The regulation of the money supply therefore depends on some- one's ability to set interest rates and thus encourage or discourage the seeking of more loans. Fractional reserve banking emerged at about the same time as a began to redeem greenbacks for gold, which effectively put the US system whereby banks were legally permitted to lend more money back on the gold standard until 1933. than they retained in deposits (regardless of whether those deposits In general, the Republicans were married to gold, while Populists, were in the form of gold or fiat money). This process seems myste- Democrats and the "Greenback Party" promoted silver and/or the rious and perhaps even a tad unethical to most people when they ini- printing of lots of paper money. They argued that gold had become tially learn of it. However, it has become the foundation of modern concentrated in the hands of the bankers; if money were to get into banking and currency systems. the hands of "real people", the government would have to issue In effect, when a commercial bank makes a loan, it creates money more fiat or silver-backed paper notes. The monetary question split from nothing. When the loan is repaid and is struck from the books, the nation for decades. that money effectively disappears. Since it has been lent into exis- Clearly, gold as money acts as a barrier to the expansion of credit tence, virtually all fiat currency in modern money economies is tied money. This can be both good and bad: it prevents hyperinflation, to debt, which requires the payment of interest. but it can also put a brake on economic activity, leading in the worst The regulation of the money supply therefore depends on some- instances to deflation and depression. In 1896, the conflict came to one's ability to set interest rates and thus encourage or discourage a head as Populist William Jennings Bryan ran against pro-gold the seeking of more loans. Republican William McKinley. Though McKinley won, gold's time had passed. Early Life of the US Dollar Following the Depression of 1907, Congress passed the From this point on, we will focus our attention on a particular cur- Owen-Glass Federal Reserve Act of 1913, which established the rency: the US dollar. national banking cartel that controls the nation's currency to this During the Revolutionary War the provisional authorities issued day. The Federal Reserve (known colloquially as "the Fed") is a paper money, which led to counterfeiting by the British and to vari- peculiar hybrid government-private institution whose chairman is ous other forms of fraud. appointed by the US President but whose stock is entirely owned by The 1792 US Coinage Act provided for a national Mint where sil- member banks. In effect, the Fed is a private corporation owned by ver dollars were to be produced along the interests that it nominally regulates on with gold coins, beginning in 1794. The behalf of the people. Act states: "The Dollar or Unit shall be After the Fed's establishment, the of the value of a Spanish milled dollar government quickly recalled its as the same is now current, to wit, three Treasury Notes and the Fed began issu- hundred and seventy-one and one-quar- In effect, when a ing Federal Reserve Notes with a ter grains of silver." The Act also pre- commercial bank makes promise to redeem them for gold upon scribed the death penalty for anyone 4 demand. Congress also handed the Fed debasing the national currency. a loan, it creates money control of the nation's gold. The Fed The framers of the American i then began lending back the gold, at Constitution were divided on the ques- from nothing. interest. tion of whether their new nation should The Fed's tools for controlling the have a national bank. Proponents (who economy are few but powerful. It sets were themselves bankers or future the rules for member banks for fraction- bankers) argued that a national bank al reserve banking (money creation) and would be necessary for the proper regula- sets the discount rate (the rate of interest tion of a national currency; opponents argued that such an institution charged to member banks for the privilege of creating money). would effectively give a tiny banking elite control of the nation's When the federal government wishes to take out a loan to pay for a economy. The opponents won: Article I of the US Constitution new bomber or highway, it effectively borrows the money from the gave Congress the power to coin money. Fed (though the debt usually then gets spread around to various However, the proponents of a national bank, led by Alexander domestic and foreign investors), which thus controls not only the Hamilton, did not give up. At the time, local banks issued other cur- nation's monetary system but government credit as well. The bene- rencies in addition to the fledgling national currency. The nation fits issuing from the flow of insider information that results from needed a single currency and a way of financing the government. that control are unknown but surely considerable. The Fed's deliber- All of the government's financial needs, said the Hamiltonians, ations occur in secret and the institution has never been audited. should be underwritten by funds borrowed from the national bank Even after the Fed's creation, several kinds of currency existed and repaid by the government with funds raised by taxation from the from time to time during the early 20th century, including United people. Thomas Jefferson led the opposition. States Notes, Gold Certificates and Silver Certificates. But, from Twice in the 19th century a national bank was established (in about 1965 to the present, virtually all US currency has consisted of 1791 and 1817), and twice abolished (the first time in 1811, the Federal Reserve Notes—i.e., money created not by the government second in 1832, both times on charges that the bank was corrupt and (which merely prints the paper notes themselves, which it sells to unconstitutional). Further attempts were made to establish a the Fed for the cost of printing), but by the Federal Reserve and its national bank until the early years of the 20th century, but these member banks. were rejected on constitutional grounds. On March 9, 1933, at the deepest point of the Great Depression, The nation's money, controlled by the government, was some- Franklin Roosevelt issued Executive Orders 6073, 6102, 6111 and times a fiat paper currency and sometimes backed by gold or silver. 6260, effectively declaring the US bankrupt. On April 5, 1933, Periods of inflation or deflation led to depressions. Private banks Roosevelt declared a National Emergency that made it unlawful for continued to issue their own banknotes as currency until the endof any citizen of the United States to own gold, and ordered all gold the Civil War, during which Lincoln floated millions of dollars in coins, gold bullion and gold certificates turned in to Federal Reserve fiat "greenbacks" in order to finance the army. In 1878, Congress banks by May | under the threat of fines and imprisonment. On In effect, when a commercial bank makes a loan, it creates money from nothing. 12 = NEXUS www.nexusmagazine.com DECEMBER 2004 — JANUARY 2005