Elastic Currency: Inelastic Economy by James Jaeger
Below is a typical argument issued by apologists of the Federal Reserve System to justify its existence. This academic double-speak is entitled "Origins of the Federal Reserve System: International Incentives and the Domestic Free-rider Problem by J. Lawrence Broz. Broz cites Bernanke as one of his sources throughout. The original paper, which I encourage you to look at, is impressively formatted as a PDF file at http://weber.ucsd.edu/~jlbroz/originsFed_IO.pdfI will first present a section of this article in full so you can digest its spin. I will then explicate the section to specifically point out elements of the "spin" and argue that the Federal Reserve System, and the "reasons" it "had" to be formed, are bank-serving, special interests, if not completely bogus.
BROZ WROTE:Financial System Stability as a Public GoodThe financial system is the infrastructure on which the functioning of the entire economy rests. When a financial system is operating smoothly, it is almost invisible. Advances and transfers of money take place between individuals and runs with little regard to the underlying infrastructure, facilitating exchange and maximizing aggregate social welfare. In this sense, financial system stability is literally a public good, and the beneficiaries include nearly all citizens of a nation. The public nature of financial stability is especially clear in its absence. When a financial system is unreliable or prone to collapse, people become aware of it because the costs of its poor organization are made manifest in forgone everyday exchange. Breakdowns in financial intermediation services reverberate through the real economy, causing a reduction in economic activity, higher unemployment, and increased commercial failures.5
Yet simply because society at large benefits from a sound financial system does not make its provision automatic. Provision is problematic because any effort to improve the infrastructure is itself a public good and, therefore, subject to the dilemmas of collective action-free riding, undervaluation, and underprovision. The following discussion demonstrates these points empirically, with respect to the instability of the U.S. financial system before 1914. The National Banking Acts of 1863, 1864, and 1865 determined the basic structure of the U.S. banking system until 1914.6 The legislation had two main purposes: to provide a uniform national currency and to raise revenue for the federal government during wartime. Prior to 1863, the national currency supply consisted primarily of notes issued by literally thousands of state-chartered banks. The problem was that the notes of these banks circulated at various discounts from par, depending on the reputation of the issuing bank, the time passed since the note was issued, and the distance to the issuing bank. Determining the quality of a particular note involved unnecessarily high transaction costs. The national banking legislation substantially reduced these costs by allowing for the incorporation of banks chartered by the federal government (''national banks'') that would issue currency backed fully by U.S. government bonds. By effectively making all bank currency a liability of the government, and, therefore, risk-free, the bond collateral feature did create a uniform currency that circulated at par throughout the country.7Another motive, however, was to create an artificial market for government debt. Requiring banks to secure their note issue with Treasury securities increased demand for government bonds, and the provision was thus valued jointly as a revenue-raising measure during the CivilWar.
Although the system succeeded in establishing a uniform currency (and raising revenue for the government), it did not solve all the defects of the financial system. The remaining law was that the currency was ''inelastic'' in the short run, which led to large seasonal swings in interest rates and banking panics. None of the various forms of currency in circulation-national bank notes, gold and silver coin, gold and silver certificates, and greenbacks-could vary much in the short run.8 Law fixed the quantity of greenbacks, gold and silver certificates could be issued only if the Treasury held equivalent specie as backing, and the use of silver was rigidly controlled. The supply of national bank notes, in turn, tended to exhibit ''perverse elasticity,'' contracting when it should have expanded. National banks had to obtain government bonds to issue additional notes, a slow and expensive process; moreover, they could not issue notes against general assets. When bank reserves were low and business very active, banks could ill afford to have their funds tied up in bonds and redemption deposits, resulting in a contraction of the note supply. The underlying cause of this short-term rigidity, however, was the absence of a central bank. Although the United States had maintained a central bank during much of the antebellum period, the most distinctive feature of the national banking period was the absence of an institution with the power to provide funds at times of high demand through a discount window or through open market operations. Other institutions, however, attempted to fill this void. The most important example was the New York Clearinghouse Association, which became a quasi-central bank in the nation's financial center.
Most banks in New York were members of the city's clearinghouse association because of the services the association offered in settling payments between banks. But the clearinghouse evolved to take on the function of pooling member bank reserves and issuing emergency currency (known as ''loan certificates'') during panics. 9 Although there was no legal mechanism to increase the supply of currency quickly, loan certificates provided a private, if unlawful, way to free up a sizable amount of cash. The issue of loan certificates thus reduced somewhat the need for a central bank to provide liquidity during crises. But the clearinghouse was not sufficiently powerful to have major effects on the quantity of reserves, and there were numerous panics despite the use of loan certificates.
In the absence of a true central bank, short-term rigidity in the supply of currency caused problems with respect to seasonal shifts in demand for currency, arising from the annual agricultural cycle. In the fall, during the harvest season, the demand for currency was intense, since agriculture still accounted for a large share of economic activity and cash was required for many farm transactions.10 With supply held rigid, interest rates were driven upward.11 This deviation of interest rates from their trend level was suboptimal since it did not arise to counter overheated macroeconomic conditions. The extra demand derived solely from the need to ''move the crops.'' Banks were thus induced to run down their reserves in the fall, which left them vulnerable to runs. As Jeffery Miron documents, panics occurred with much higher frequency in the autumn, when high interest rates and low deposit-reserve ratios prevailed.12
Panics were the most obvious manifestation of the inelasticity problem during the national banking period.13 Major panics occurred in 1873, 1884, 1890, 1893, and 1907.14 In addition, there were twenty-four lesser panics between 1873 and 1909.15 Although the immediate cause of each panic varied, ranging from the failure of a specific bank to a stock market crash, the most serious panics (1873, 1893, and 1907) ended only after solvent banks everywhere had suspended the convertibility of deposits into currency.
The effects of panics were not restricted to the financial sector alone.16 Suspension of payments, which lasted from one to three months, was one mechanism that transmitted the shock to the real sector of the economy. Suspension meant that banks closed their doors to firms and individuals needing currency to meet payrolls or make transactions, causing disruptions in economic activity and increasing the number of commercial bankruptcies. When banks suspended payments, brokers began buying and selling currency at a premium to deposits. Such premiums, which averaged 1 to 2 percent and ranged as high as 4 percent in 1907, reflected the wealth lost by depositors. In addition, banks were forced to curtail loans and ration credit, due to pressure on their reserves. Even if credit contraction was only momentary, the effects on the real sector were often severe, since firms relied on short-term loan facilities to finance commerce and temporary shortfalls. Table 1 provides some evidence of the economic costs of major panics during the period.17 In summary, seasonal interest-rate fluctuations and the shortages of a medium of exchange during panics imposed large costs on American society. These problems were largely rectified with the establishment of the Federal Reserve, justifying the claim that the installation of the Fed was a public good. The principal reason for the founding of the Federal Reserve was to assure stable and smoothly functioning financial markets, a function that predates the more purely monetary functions of engaging in open market and foreign exchange operations and setting reserve requirements. Miron shows that the frequency of panics and the size of seasonal movements in interest rates declined substantially after the founding of the Fed.18 The realization of these generalized and nonexcludable benefits, however, does not square with the narrow scope of the lobbying effort undertaken by New York bankers (discussed later) in the run-up to the legislation. My claim is that money-center bankers took up the cause because they sought a separate, group-specific benefit-namely, the internationalization of the dollar. As documented in this article, the national banking
4. Humphrey 1990.
5. Bernanke and Gertler 1990.
6. See James 1978; and White 1983.
7. Cagan 1963.
8. Friedman and Schwartz 1963, 168-69, 292-95.
9. See Timberlake 1993, 198-213; and Gorton and Mullineaux 1987.
10. Eichengreen 1984.
11. See Champ, Smith, and Williamson 1996; and Miron 1996.
12. Miron 1986.
13. Champ, Smith, and Williamson 1996.
14. Sprague 1910.
15. Kemmerer 1910.
16. Economists differ on how financial disturbances influence the real economy. For a test of the two main hypotheses , see Bordo, Rappoport, and Schwartz 1992.
17. For a fuller accounting, see Grossman 1993.
18. Miron 1986, 125.
>Financial System Stability as a Public GoodJAEGER WROTE:
What a joke, a public good.>The financial system is the infrastructure on which the functioning of the entire economy rests. When a financial system is operating smoothly, it is almost invisible.
True.
>Advances and transfers of money take place between individuals and runs with little regard to the underlying infrastructure, facilitating exchange and maximizing aggregate social welfare. In this sense, financial system stability is literally a public good, and the beneficiaries include nearly all citizens of a nation. The public nature of financial stability is especially clear in its absence. When a financial system is unreliable or prone to collapse, people become aware of it because the costs of its poor organization are made manifest in forgone everyday exchange. Breakdowns in financial intermediation services reverberate through the real economy, causing a reduction in economic activity, higher unemployment, and increased commercial failures.5 Yet simply because society at large benefits from a sound financial system does not make its provision automatic. Provision is problematic because any effort to improve the infrastructure is itself a public good and, therefore, subject to the dilemmas of collective action-free riding, undervaluation, and underprovision. The following discussion demonstrates these points empirically, with respect to the instability of the U.S. financial system before 1914.
Some say this was the nation's greatest period of prosperity.
>The National Banking Acts of 1863, 1864, and 1865 determined the basic structure of the U.S. banking system until 1914.6 The legislation had two main purposes: to provide a uniform national currency and to raise revenue for the federal government during wartime.
Borrow money to wage wars. If citizens don't feel a war is important enough to finance with taxes, then it's not important enough to fight. Where do governments get off on BORROWING to fight wars? Where did THIS start?
>Prior to 1863, the national currency supply consisted primarily of notes issued by literally thousands of state-chartered banks. The problem was that the notes of these banks circulated at various discounts from par, depending on the reputation of the issuing bank, the time passed since the note was issued, and the distance to the issuing bank. Determining the quality of a particular note involved unnecessarily high transaction costs.
I agree with this, having a non-uniform currency issued by many banks is a massive headache. This function of the Federal Reserve System is good. Creating a UNIFORM currency.
>The national banking legislation substantially reduced these costs by allowing for the incorporation of banks chartered by the federal government (''national banks'') that would issue currency backed fully by U.S. government bonds.
Note the spin here that apologists of the Fed always use.
Statement 1: The Fed issues currency that is fully backed by U.S. government bonds.
Statement 2: The government borrows money by issuing bonds which the Fed then "buys" by, in essence, printing up paper currency which it then uses for the "purchase."
Statements 1 and 2 are mechanically identical but which statement makes the Fed look great and which statement makes the Fed look like the fraud it is?
>By effectively making all bank currency a liability of the government, and, therefore, risk-free, the bond collateral feature did create a uniform currency that circulated at par throughout the country.
What a crock. Fed apologists would have one believe that "backing" a currency with a DEBT makes it "risk-free." Where do we live, Oz? This is bogus double-talk designed to obfuscate from the public what's really happening. The author of this paper should be convicted for conspiracy to defraud the public.
>Another motive, however, was to create an artificial market for government debt. Requiring banks to secure their note issue with Treasury securities increased demand for government bonds, and the provision was thus valued jointly as a revenue-raising measure during the CivilWar.
This is the old partnership between the Fed bankers and the Congress we discuss in FIAT EMPIRE at http://www.FiatEmpire.com. Securing a note, an IOU, with a debt instrument, a Treasury security, is as flaky as it can get. No wonder the financial stability of the U.S. is in chaos at this writing. The "demand" for government bonds is totally artificial. When the Fed can print up as much money as it wants to "buy" the bonds, of course it will stimulate artificial demand. Again, bogus financing.
>Although the system succeeded in establishing a uniform currency (and raising revenue for the government), it did not solve all the defects of the financial system.
Possibly the only defect the pre-1913 financial system had was that the currency was not uniform and banks were collecting interest on fraction and/or fiat money thus draining the system of needed capital.
>The remaining flaw was that the currency was ''inelastic'' in the short run,
Inelastic is the double-speak apologist use for the term FIAT. Inelastic = fiat, so when you hear Establishment apologists use this term, you will know what they are referring to.
>which led to large seasonal swings in interest rates and banking panics.
Large swings in interest rates are what are SUPPOSED to happen in a free market economy. The COST of money is SUPPOSED to go up and down in accordance with supply and demand. Everything else in the universe goes up and down with supply and demand, what makes money anything special? Only the double-speak from Fed apologists makes money anything more special.
And seasonal? Oh no other business have SEASONAL expenses?! What about the movie biz?! That's seasonal: SUMMER and WINTER are when the movie industry HARVESTS its product.
>None of the various forms of currency in circulation-national bank notes, gold and silver coin, gold and silver certificates, and greenbacks-could vary much in the short run.
Very?! Why do they need to vary in supply? All that's important is the commodity known as money VARIES in VALUE even though its weights and measures are to be kept constant by the government. When the value of money goes up and down, the economy can stay stable. This is the whole idea. The Fed bankers have it backwards: they are trying to keep the value of money stable, thus they have created an economy that booms and busts -- and had the gal to insitutionalize this calamity as the so-called Business Cycle, again to obfuscate their folly and greed.
>Law fixed the quantity of greenbacks, gold and silver certificates could be issued only if the Treasury held equivalent specie as backing, and the use of silver was rigidly controlled.
Huh? This makes no sense. Law pursuant to the Constitution specified exactly how much silver was to be considered a "dollar." Law pursuant to the Constitution specified exactly how much GOLD was to be considered a "dollar." These silver and gold COINS were MONEY and the only "THINGS" that were money. See Article I, Sections 8 & 10 of the U.S. Constitution. Paper CURRENCY was issued as "Silver Certificates" and Gold Certificates" to REPRESENT the REAL MONEY, which was the actual gold and silver coins. Bills of credit (i.e., Federal Reserve Notes) are not allowed pursuant to Article I. The way Broz words this is to complicate the issue and obfuscate the simplicity of Constitutional intent. Yes the entire idea of the Founders is for the Treasury to NOT issue MORE money than it HAS. This idea is, of course, incomprehensible for a modern-day Fed bankster.
>The supply of national bank notes, in turn, tended to exhibit ''perverse elasticity,''
Perverse elasticity! Wow, that sounds really bad. Can't have any perverse elasticity can we. What Brozo means here is, the fiat money was doing its job limiting MAL-investment until capital formation and more efficient production from solid businesses provided real growth and CHEAPER products for society. Remember, as society progresses, the cost of products should DECREASE, not increase, as they do today. In the inverted world of Broz-speak, money with increasing purchasing power is known as "perverse elasticity." Too funny.
>contracting when it should have expanded.
No, the money supply should neither be contracted or expanded according to economist Murray N. Rothbard. See "WHAT HAS GOVERNMENT DONE TO OUR MONEY" at http://mises.org/rothbard/rothmoney.pdf. It should be held stable while civilization expands productivity. The only thing about money that should expand is its PURCHASING POWER.
>National banks had to obtain government bonds to issue additional notes, a slow and expensive process; moreover, they could not issue notes against general assets. When bank reserves were low and business very active, banks could ill afford to have their funds tied up in bonds and redemption deposits, resulting in a contraction of the note supply. The underlying cause of this short-term rigidity, however, was the absence of a central bank.
This last paragraph is designed to make it all look so complicated, the only solution MUST be a central bank. This is a typical tactic, overwhelm with pseudo-academic nonsense designed to keep the public reliant on banks and their monetary scientists. A free-market economy works with powerful simplicity.
>Although the United States had maintained a central bank during much of the antebellum period,
He conveniently fails to mention the U.S. had two central banks which were closed down as soon as the citizens realized the fraud of central fiat banking.
>the most distinctive feature of the national banking period was the absence of an institution with the power to provide funds at times of high demand through a discount window or through open market operations.
You don't provide funds at times of high demand, this is banker-speak for issuing loans. Bankers ALWAYS want to "provide funds" because this is how they earn their living: interest on loans. The cheaper they can get -- or make -- their product, MONEY, the more their profit-margin.
>In the absence of a true central bank, short-term rigidity in the supply of currency caused problems with respect to seasonal shifts in demand for currency, arising from the annual agricultural cycle. In the fall, during the harvest season, the demand for currency was intense, since agriculture still accounted for a large share of economic activity and cash was required for many farm transactions.
Again, the author is attempting to justify the need for a central bank with "seasonal shifts in demand." Nowhere does he state specifically WHO needs the additional money. Does the farmer need additional money or do the vegetable-eating public need the additional money? So at harvest the supply of crops increases thus reducing the demand for currency to buy them or what? None of this rationale applies to today's civilization anyway when crops and harvests come from all parts of the world and there is an active futures market to level out prices for farmers.
>With supply held rigid, interest rates were driven upward.
So what? Interest rates are SUPPOSED to be driven upwards. The only ones that don't like high interest rates are borrowers. Bankers love high interest rates because they can charge more for the money. The only time they don't like high interest rates is when they can't create additional "money" out of thin air to rent. This is the entire point of their fiat money scam: make endless amounts of fiat money out of thin air so they can garner as much interest as possible at whatever rates they can force on the public.
>This deviation of interest rates from their trend level was suboptimal since it did not arise to counter overheated macroeconomic conditions.
Oh, so now interest rates have a "trend" they must follow. Interest rates are like the stock market. And this deviation is "suboptimal" because the only use for a high cost of money is to cool down an economy. What a crock. If this isn't mixing cause with effect, and even mixing the two in an anachronistic manner. An "overheated" economy is the RESULT of too much fiat money. When interest rates trend up or down, because the money supply remains stable, the economy CAN'T overheat, thus 'suboptimal interest rates do not NEED to rise to counter overheated macroeconomic conditions.' Good try apologist Broz.
>The extra demand derived solely from the need to ''move the crops.''
So let me get this, extra demand for money is caused solely because some farmer needs to move his crops. Please. And I supposed no one else in the economy has to move anything.
>Banks were thus induced to run down their reserves in the fall, which left them vulnerable to runs.
See, here's a perfect microcosm of the banker mentality. The banker thinks it's all about him and his bank. The economy exists to serve the banker and HIS reserves, HIS interest and HIS risks. The banker is the most egocentric pig that ever existed. Money is NOT the property of BANKERS. Money is the property of CITIZENS and anyone who uses their blood, sweat and tears to create something of REAL value, not "value" from thin air fraud. The citizens hard work-value is then converted into a medium of exchange for the CITIZENS, not the banks. The medium of exchange is between the citizens not between the citizens and the bankers. Bankers create little of value. They are MIDDLEMEN, parasitic middlemen. The consideration of how much RESERVES any bank has is irrelevant to civilization. The important consideration is how much RESERVES do common citizens have -- the ones that actually create products and services that have real value. This is what we mean by CAPITAL FORMATION, also known as savings. When citizens SAVE, and companies save capital, THEY are creating reserves. These are the only reserves that one should be concerned with. To hell with banks' reserves. So what, if banks have no reserves due to farmers selling crops; what are we going to do, set up a central banking system that can print up infinite amounts of reserves so the BANKS can sit fat and happy and charge interest on this mountain of bogus reserves? Well we have already allowed a rogue Congress to do this while we were asleep. That's the system we have allowed the banking and government crooks to put together at that secret meeting on Jekyll Island in 1910. See SECRETS OF THE FEDERAL RESERVE at http://www.apfn.org/apfn/reserve.htm
>As Jeffery Miron documents, panics occurred with much higher frequency in the autumn, when high interest rates and low deposit-reserve ratios prevailed.
Scholars have documented the fact that the banks CAUSED these panics to justify the adoption of a central bank.
>Panics were the most obvious manifestation of the inelasticity problem during the national banking period. Major panics occurred in 1873, 1884, 1890, 1893, and 1907. In addition, there were twenty-four lesser panics between 1873 and 1909. Although the immediate cause of each panic varied,
Well if the immediate cause of each panic VARIED, how can you say the cause was inelastic currency. Again, scholars have documented the fact that the banks CAUSED these panics to justify the adoption of a central bank.
>ranging from the failure of a specifc bank
And this is fine. This is what free-market capitalism is all about. Individual banks fail for imprudent business practices. Today, the banks walk in lock-step as the Federal Reserve System. As a result the MONEY is now elastic whereas the entire system is now INELASTIC. The banks have been allowed to grow so large, due to no weeding out process as above discussed, the failure of one, or a few, large banks destroys the ENTIRE economy -- unless it's bailed out under the doctrine of "too large to fail" -- a tired doctrin G. Edward Griffin explicates in his book, THE CREATUIRE FROM JEKYLL ISLAND. The PURPOSE of allowing smaller banks TO fail is to provide a release valve for the ENTIRE economy. Again, we now have an ELASTIC currency and an INELASTIC ECONOMY because the banks and their affiliated insitutions (brokerage houses and insurance companies) have been allowed, through invasive government regulation and special priviledges, to grow "too large to fail." How convenient for a government hell-bent on becoming a cultural Marxist, socialist empire run by corporate fascists.
>to a stock market crash, the most serious panics (1873, 1893, and 1907) ended only after solvent banks everywhere had suspended the convertibility of deposits into currency.
Why didn't he just say they closed their doors and took the depositors cash.
>The effects of panics were not restricted to the financial sector alone. Suspension of payments, which lasted from one to three months, was one mechanism that transmitted the shock to the real sector of the economy. Suspension meant that banks closed their doors to firms and individuals needing currency to meet payrolls
Apologists of the Fed and bailout artists always bring the payroll thing into the equation to scare citizens into the central bank-trap or the next bail-out scenario. In an economy with plenty of capital formation, firms can keep their payroll cash in the company vault, where it's safe from the door-closing banksters.
>or make transactions, causing disruptions in economic activity and increasing the number of commercial bankruptcies.
Oh, we can't have any BANKruptcies. The idea being that when a company goes belly up, it interRUPTS the BANKS ability to collect interest payments. Again, all bank-centric ego.
>When banks suspended payments, brokers began buying and selling currency at a premium to deposits. Such premiums, which averaged 1 to 2 percent and ranged as high as 4 percent in 1907, rected the wealth lost by depositors. In addition, banks were forced to curtail loans and ration credit, due to pressure on their reserves. Even if credit contraction was only momentary, the effects on the real sector were often severe, since firms relied on short-term loan facilities to finance commerce and temporary shortfalls.
Under the guise of providing liquidity, credit and stability, a fiat money system makes all manner of money-games possible, games that accumulate to inhibit and destroy the productivity of civilization. Banking should be a non-profit industry, as should religion, law and medicine. Thoughtful people should unite to remove the money-motivated, greedy psychopaths from the world's service-commodity industries, otherwise it will never become a Class II Civilization.
Originated: 26 September 2008
Revised: 27 September 2008
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