The Illusion of a Riskless Society; E. Groseclose

Elgin Groseclose The Illusionof a Riskless Society THROUGHOUThistory the fear ofin security, from floods or famine, from enemies without or within, has dri ven mankind to erect barriers against the onset of disaster. Throughout history also such barri ers-from the barns that led the man of the parable to tell his soul to take its ease, to the walls that cities have built that eventually fell to some in vader-have proved illusory. In this country, protected as it is by the barriers of two great oceans, the search for security is no less fear driven, but its direction, in an in creasingly monetized society, is in a search for bastions. And since this is an increasingly socialized society, a chief aim of political policy has been to provide, through governmental Dr. Elgin Groseclose, a financial consultant in Wash ington, D.C., is the author of Money and Man (1934, 4th edition 1976) and America's Money Machine(1966, 1980). He serves also as executive director of the Institute for Monetary Research.

464 agencies and power, what is cur rently referred to as a "safety net" for every citizen. Yet as we may observe, the search for such security has proven illu sory-mainly because of decay of its fabric, that is, the monetary stan dard of which the net is woven. We may review a number of these ef forts by government. First Effort-Riskless Banking Throughout the latter decades of the nineteenth century, "check book money" came into increasing use as a medium of payments. But check book money depended upon the sol vency of the bank in which the real money was deposited. Bank failure~ became a periodic feature of eco nomic history. In 1913, following the "rich man's panic" of 1907, the result of over speculation and bank failures, pub lic outcry for a "flexible currency" brought forth the Federal Reserve System designed, in the words of the Secretary of the Treasury, to "make panics mathematically impossible."

Banking was to be made riskless for both banks and depositors by allow ing overshot banks with cash short ages to trade collateral for legal tender currency at the Reserve banks. With this assurance of li quidity, banks were now allowed to reduce their capital reserves against deposits from a standard 25 per cent to a sliding scale down to 12 per cent THE ILLUSION OF A RISKLESS SOCIETY 465 and as low as 5 per cent on time de posits. Under subsequent legislation and regulations, also, banks were able to shift more and more of their assets from short term self-liquidat ing commercial paper to long term mortgages and bonds, thereby im pairing their liquidity and ability to meet sudden withdrawals. This effort to create riskless bank ing collapsed in the securities mar ket panic of 1929 which led to the bank "holiday" of 1933 when every bank in the country was forced to close its doors.

SecondEffort-RisklessDeposits The country now concluded that, however feeble the banks might be, whatever extravagant lending they might indulge in, their customers, at least the smaller ones, should be protected and their deposits made riskless. This led to the enactment in 1933 of deposit insurance legisla tion by which eventually two mam moth government corporations, the Federal Deposit Insurance Corpora tion and the Federal Savings & Loan Insurance Corporation, were set up "to restore confidence in the bank ing system and protect depositors." By 1979 the futility of this effort became evident to the bank regula tors. Thus, in 1979, William M. Isaac, president of the FDIC Corporation, pointed out that the risk assets of the banking system-total assets less cash and equivalents-had risen from 22 per cent in 1945 to 80 per cent by 1978. ',He commented omi nously, "One would think that with banks assuming greater risks, and the economy more volatile, capital ratios would be increasing. Just the opposite." He cited that equity to risk, that was around 30 per cent in 1900, had dropped steadily to around 8 per cent in 1978.

Today. the eause for concern is greater. The New York Times for January 25, 1~82, noted that of the 15 largest bank holding companies, the equity to assets ratio ranged from 4.55 per cent to as low as 3.25 per cent; and we may add that if bank ers' portfolios!were valued at mar ket, the result: in many cases would be a negative ratio. Take, for in stance, a Aaa bond like AT&T 7s of 2001, issued ih 1971 at 99.25, that has sold recently for as low as 50. Presently the savings and loan as sociations are approaching crisis under the necessity of borrowing at rates up to 15 per cent against mort gage assets acquired when rates were as low as 8 per cent; and each day brings reports of new mergers and takeovers to. save failing associa tions from outtright default. The most recent merger was reported on March 24, 1982, "to:avert what would be the biggest bank failure in the na tion's history."

With custqmers' deposits now guaranteed up to $100,000, the $8 billion insurance fund of the two 466 THE FREEMAN August corporations has become totally in adequate as guarantee. This has led to legislation to back up deposits by the "full faith and credit of the U.S." regardless of the adequacy of the in surance fund. A bill to this effect was passed by the House with only 10 minutes of debate; its fate in the Senate has not (at this writing) been resolved. Other proposals are for the government to subsidize $210 bil lion in old low-interest mortgages by paying half the difference between the yield and the market rate on current deposits-a procedure that The New York Times estimates could cost the taxpayers from $4 to $5 bil lion a year for many years. Third Effort-Riskless Aging In 1933 the government under took to guarantee income for the aged through a Social Security system by which a percentage levy was laid on earned income, the proceeds of which were invested in government bonds, from which payments were made as the contributor reached retirement age. Starting out at a modest per centage of earned income, the levy has steadily increased to a 1981 tax of 9.3 per cent on income up to $29,700. Since the tax receipts were invested in government bonds, for nearly 50 years the system has been a means of covering federal budget deficits; today, however, due to steady increase in benefits, the system is facing bankruptcy unless relieved by further taxes either from the income contribution or general revenues.

When Joseph foresaw a famine in Egypt he stored harvest surpluses of the good years in granaries against the years of dearth. Such a method is impossible today in a system of debt money. Who is to provide cash against the bonds but the very ones who are in need? Fourth Effort-Riskless Prices Since 1922 government policy has been to stabilize prices in order to protect producers of goods and ser vices from loss from price fluctua tions. This is theoretically achieved by the Federal Reserve System in buying and selling government bonds to provide an even supply of money. But the essence of trade is differ ences in prices. If all prices were sta ble, enterprise would wither, as the effect of rent control on housing sup ply has demonstrated. If modern technology means anything it is to make goods cheaper. The secular effect of the policy of maintaining prices has been a steady increase in prices, with the increase steadily accelerating until it reached double-digit rates in 1980 and produced a voters' revolt.

Fifth Effort-Riskless Money All the efforts to remove risk from banking, from livelihood, from en terprise have been, as we have noted, through the agency ofmoney. Money 1982 THE ILLUSION OF A RISKLESS SOCIETY 467 is the foundation stone in the wall of security. But money, no longer a substance, like gold or silver, but an I.O.D. of the Federal Reserve Sys tem, a note without maturity, melts away like shifting sand under the cyclical rainfall of business. The last element of substance in money disappeared in 1971, when the "gold window" was finally closed on international holders ofdollars. Since then, holding money has become the greatest risk of all. This has become evident in the rising interest rate demanded by lenders to offset the erosion of the dollars due them. This rise in interest rates has been going on for the past 40 years, generally unperceived until the last decade. Sixth Effort-Speculation The disappearance of financial stability has led inevitably to a surge of speculation and gambling. As the Minority Report of the Gold Com mission points out, scheming, spec ulation, and sophisticated tax avoid ance have replaced productive effort, savings, and planning for the fu ture.

Trading in currencies, the Report adds, has become more rewarding to banks than conventional business of brokering loans from savings. The futures and options market has turned into a giant gambling game. Futures are sold in currencies, and more recently futures and options on stock-indexes. In 1980 more futures on Treasury bonds were sold on the Chicago BoardiofTrade than on cat tle. Billions of! dollars are obtained from banks by corporations for the purpose of "takeovers" of other cor porations with no indicated purpose of developing new industries or sources of basic wealth. Gambling has become a state enterprise. Ille gal for individuals, in 1980, over $2 billion was gained from official lot teries for the benefit of state govern ments. The High Road to Stability Despite the, evidence of an in creasingly unstable society due to the monetary standard in which busi ness is done-despite also a so-called "tight money policy" by the Federal Reserve-the printing press contin ues to roll and the amount of debt on demand continues to rise. Between February 28, 1981, and February 28, 1982, corresponding closely with the first year of the Reagan Administra tion' the legal itender circulation in creased from '$131,862 million to $140,525 million, while the demand debt of the Federal Reserve bank and banking system (called M1) rose from $424 billion to $447 billion. Since none of this debt is dischargeable in any legal ten,er but irredeemable paper, it is obvious that until the powers of the Federal Reserve to create fictitious money are cur tailed, no degJiee of stability will be achieved. ® John Hospers Rothbard's Liberty Reviewed The Ethics of Liberty by Murray Rothbard. (Atlantic Highlands, N.J.: Humanities Press, 1982), 268 + x pp., $15.95 hardbound.