Manning the Sea Walls; E. Groseclose

For the United States, with busi ness bankruptcies soaring and the banking system tottering, confi dence has begun to ebb in the power of the omnipotent Federal Reserve to control the flood.Although it mans the sluice gates of a mighty reser voir of credit, some see cracks in the great dam below which the economy sits like a present-day Johnstown. One journalistic commentator de clares that the country faces its greatest economic crisis in fifty years. The Great Debate A popular cry is to denounce Re aganomics with its devotion to free market economics; more radical theorists accuse the capitalistic sysMANNING THE SEA WALLS 25 tern and argue for authoritarian communist and socialist forms of government. Advocates of more governmen.t in tervention, however, face the di lemma that the crisis is severest in the Third World, most of which is governed by Marxist or socialistic principles under authoritarian re gimes. Indeed, it is the collapse of Third World economies, despite a thirty-five year drain of Western re sources under various foreign aid programs, that has complicated the problems of the West; it is the de faults of Third World countries on loans from Western banks that now threaten the international banking structure.

Advocates of more government subsidies and intervention, how ever, ignore the fact that if Reagan omics has not borne the expected fruit, it is because of its failure to extend free market principles into the most important area of enter prise-the money system. Despite dismantling of many gov ernment barriers to trade, money which is the lifeblood of enter prise-remains under authoritarian controls by a bureaucracy as aloof, as unrestrained, as a Soviet Polit bureau. This is the Open Market Committee of the Federal Reserve which congeals the wisdom of twelve mortal beings enjoying long tenure into directives as to the amount and direction of money flow; each Friday the markets of the world await with bated breath the effect of their de liberations. Historical Review of System The development of this auto cratic power was gradual and often unperceived. For twenty-seven cen turies, mankind regarded as axiom atic that the only valid means of payment is intrinsic money, that is, coinage. Rulers throughout history, however, have wherever possible circumvented this principle by de grading or counterfeiting the coin age. The most pervasive effort was in 13th-century China, when the Mongol emperors substituted paper notes for metallic coinage in circu lation. The Venetian traveler Marco Polo admired the device which, he noted, gave the emperor enormous profits. Despite the inflation that followed, with the notes at a dis count, the practice spread to Europe; but in the Middle East, efforts to in troduce paper notes were resisted by sedition, and in India, silver re mained the standard money of ac count until the British introduced paper in 1893. The British paid the price; within 20 years they nearly lost their colony but for a U.S. res cue operation. Iran had only metal lic money until the 1930s when Reza Shah introduced central banking, a La the Federal Reserve; this mon arch lost· his throne before a decade had passed.

26 THE FREEMAN January Rise of "Scientific" Economics The framers of the United States Constitution rejected paper cur rency, but despite Constitutional doubts, paper currency was intro duced as a war measure during the Civil War; specie payments were re sumed in 1879. Meantime, there had been grow ing up in the 19th century a school of thinkers employing the concepts of mathematics and physics; they obtained respect for their novel the ories by designating them as "sci entific." Karl Marx called his theory "scientific socialism." Their view was that man was a creature of physical wants and demands that could be measured statistically and pro gramed mathematically. The profession acquired status after World War II by the formation of an official Council of Economic Advis ers, enjoying access to the head of state and more influential than the Secretary of the Treasury or the Secretary of State. Added prestige came in 1969 when a Nobel Prize in "economic science" was set up along with those in medicine and physics.

From this new profession came the philosophical framework for frac tional reserve currency which came into being in 1913 with the Federal Reserve System. With fractional re serve currency, the Reserve banks were authorized to convert into cash the debt of member banks. In ex change for the member bank's paper the Reserve banks could issue legal tender notes up to 21/2 times the amount of gold money held by the bank. The process was called dis counting. At first only short term commer cial debt was generally convertible to cash, but such was the leverage given by this new mechanism, such was its power to create purchasing power by the stroke of a pen, that pressure for its expansion became irresistible. Government bonds be came acceptable collateral-this helped finance World War I-the kinds of debt expanded; if not enough debt were offered for discount the Reserve, through the Open Market Committee, could go into the mar ket and buy up debt either on the excuse of stabilizing the price level or of promoting employment. Even tually the requirement of a gold re serve was abandoned.

The Inflationary Flood and the Economic Consequences The commercial banks, with this ever-ready fountain of liquidity, ex panded their lending to the limits of their capital reserves. These dropped from around 25 percent of assets to currently less than 10 percent, with the 15 largest banks presently op erating on margins of less than 5 percent. Not finding productive use for this financial power, they have financed a rank and unhealthy growth of cor1983 MANNING THE SEA WALLS 27 porate conglom.erates with an eco nomic justification no one has yet been able to define. The system of fractional reserve currency became a world fashion like the current rage for blue jeans and .lettered T-shirts that may be found on the Ginza and in Red Square. Countries, from Ital ian principalities governing only a mountain top to continental empires like China, engaged in the issue of currency through central bank emissions.

Despite the collapse of the system in 1933, when every bank in the country closed its doors, such is the fascination with fiat currency that ever-wider powers were conferred on the System. In 1980 Reserve banks were authorized to convert to cash practically any collateral they pleased. Under this authority, the Reserve has acquired some $2 bil lion of foreign government debt, and it is now being pressed to liquidate large chunks of the debt owed to United States banks by Poland, Mexico and others. Only John Law, in his effort in 1729 to turn the soil of France into money, showed such effrontery. Despite the evidence that the main cause of the current worldwide eco nomic debauch is fractional reserve currency adopted everywhere, the Secretary of the Treasury continues to voice confidencein the System. The President tentatively suggests that it should be brought under Treasury supervision. This would be disas trous.

The correct course is to dismantle the Federal Reserve System. True Functionof Money The function of a monetary sys tem is not to manipulate the flow of credit and banking transactions to maintain a given, or even stable, price level; nor is the function to cre ate employment. The money system should be managed neither in the interest of creditors nor of debtors; neither in the interest of producers nor consumers; neither in the inter est of government nor of taxpayers. The function of government is to maintain the integrity of the stan dard; its function toward money is the same as toward the measure of length or of weight or of quantity. It is as corrupt to vary the standard of value and deferred payments as to change the length of the yard in the interest of cloth merchants, or the content of a bushel in the interest of wheat farmers. The means of maintaining the standard is the definition of the dol lar in terms of a given weight of sil ver or gold; since 1900, the sole metal of the standard has been gold; the dollar is still by law and statute de fined in terms of gold. The regime under which the money system has been corrupted came to a climax in 1934 when the mint was closed to the free coinage of gold. The mecha28 THE FREEMAN nism by which the circulation is al ways adequate to the needs of trade is that of free coinage. Under free coinage anyone can bring gold to the mint and have it coined only for the cost of mintage. Under this system the free market, rather than a bu reaucracy, determines the amount of circulating media.

Restorationof Free Coinage The system of free coinage was es tablished in England in 1666; for the first time in history the government monopoly of money ceased; during the succeeding centuries, gold flowed to England, the circulation was alMonetary Manipulation ways adequate, and England rose to be the principal· commercial power of the world. The same system was adopted by the newly formed United States, and under this system the United States became the only rival of Great Britain as a commercial and industrial power. This is the system that should be reestablished to re store stability in the United States. It is no more necessary for an inter national agreement to this end, as some argue, than for every country to agree on the length of a meter or the weight of a kilogram; the natu ral effect of integrity will compel them to do so. i IDEAS ON LIBERTY IF the nineteenth century was an era of the gold standard, free trade, and monetary stability, the twentieth century has been an era of man aged currency, protection, and monetary instability. This instability Le., violent inflation-has boded ill for international trade, which wholly depends on international payments. Inflation-the expansion of money and credit-distorts "official" exchange rates. Domestically, it tends to set in motion a flight from currency into goods. Externally, it tends to cause another flight: a flight of "hot money" fleeing to foreign sanctu aries where inflation is relatively quiescent. Inflation ultimately causes domestic prices to rise with the result that foreign importers are strongly inclined to shop harder for better bargains elsewhere ....

The past generation has been one of fantastic inflation the world over. Governments spend and spend, pumping out ever more money. One Keynesian admitted in the London Economist a few years ago: "Inflation is nine-tenths of any practical full employment policy." Inflation, in short, is the handmaiden of exchange control and protec tion. It generally spells death for free trade. WILLIAM H. PETERSON, "Barriers to World Commerce"