Through September and into October, I have been discussing the process of how free market action determines what is used as money and how the elite power brokers throughout the world havm slowly taken away the concept of real money (precious metals or other valuable commodities) and replaced it with dishonest or paper money. I think it’s important to understand just how the process or mechanism of paper money creation occurs. I will use the US as our example but there are only relatively minor differences among the many countries throughout the world which use central banking.
All the money which comes from the the Federal Reserve System is not necessarily dishonest but almost all of the honest money eventually is expanded into dishonest money. So let’s begin with the honest portion.
When the government needs funding beyond the amount of taxes it takes in, it offers US Treasury notes or bonds for sale. When these notes and bonds are purchased by private individuals or entities who use savings for the purchase, there is no money creation, only government debt increases. We are aware that many foreigners also purchase the bonds and notes offered by the US Treasury. To the extent that these purchases are the savings of private foreign individuals, again no money creation occurs.
But what happens if there are inadequate private savings or even though the savings may exist, there is not enough desire by private entities to purchase more Treasury bonds or notes? In this case, in accordance with the agreement between the US government and the private banking cartel known as the Federal Reserve Bank (the Fed) which established the Federal Reserve System, the Fed itself will purchase the bonds or notes. In essence, what happens is the US Treasury puts some fancy designs on a piece of paper and calls it a bond or note. A value is established for the bond or note with the US Treasury promising to pay back the face amount plus some amount of interest withing a specified time frame. Typical time frames are 3 months, 6 months, 1 year, 3 years, 10 years and 30 years. The Fed accepts these pieces of paper from the US Treasury and puts them on their books as an asset. In return, the Fed prints up some equally fancy pieces of paper called Federal Reserve Notes (aka dollars) and deposits these in an account at one of the 12 regional Fed banks in the name of the Treasury.
For the Fed, The Treasury bonds or notes are an asset and the dollars deposited in the name of the US Treasury in one of their banks are a liability. But the liabilities and assets are equal and the accounting books balance. For the Treasury, the pieces of paper they printed and sold to the Fed are a liability but the Federal Reserve Notes received from the Fed and deposited in one of the Fed’s banks is an asset. Again the books balance. But it’s clear that this money came from nowhere. It was created simply with the use of a printing press or more likely, with a few key stokes on a computer keyboard. In a later blog, we will discuss more thoroughly the idea of inflation but this process is pure and simple inflation. That is, the money supply has been increased without an increase in either goods or services offered in the markets on which the dollar operates. But actually, we have only witnessed so far the tip of the iceberg.
In both of the scenarios above, in the end, the government has a bank account with one of the Fed banks and there is a sum of money in it. Let’s just for the sake of ease to understand, use round numbers. We will suppose there is $1,000,000 in that account. The government has thousands of projects in which it is spending money. Let’s say that the one million dollars were spent on the reparing of a bridge that collapsed in Minnesota. The contractor who did the work gets this money and puts it in his bank.
Under the fractional reserve rules established by the Fed, this bank can use some of these funds to make loans. This is what fractional reserve banking means. Before the fractional reserve system came into being, banks and savings institutions could only make loans using funds which individuals had placed in long term savings accounts. These savers were not expecting to take their money out from the bank for a long time. They were saving for the future and the bank promised them a return (interest) for leaving it in the bank to use for loans. Both the bank and the individuals savers received a portion of the interest which the bank received for making the loan.
Under the fractional reserve system, the bank is not limited to just long term savings to be used for loans but rather all funds. So lets examine how this works. Going back to that contractor in Minnesota, let’s call his bank A Bank. A Bank now has an extra $1,000,000 on hand. The fractional reserve requirement has been in the range of 10% for many years. So A Bank takes 10% of the $1,000,000 which is $100,000 and places it on deposit with the regional Fed bank and now it has $900,000 available to make loans. A well heeled couple come into the A Bank seeking a loan to build a new house. They are planning a magnificent structure that will cost $1.5 million. They have $600,000 available in cash savings but need an additional $900,000. A Bank just happens to have the funds. After doing the necessary credit check on the couple, A Bank makes the loan. A Bank simply puts the $900,000 in an account in the name of the couple.
The couple already has a contractor. They write a check for $900,000 to the contractor so he can start work and promise to pay the remainder when the job is completed. The contractor takes the check to his bank, B Bank and deposits it in his account. Now B Bank has $900,000 it did not have previously. It takes 10% of that amount, $90,000, and places it on deposit with the local regional Fed back for its fractional reserve requirement. This leaves $810,000 available to make loans.
You can see that we can keep re-iterating this process through a series of loans, additional deposits in banks, subtracting the 10% and so on. Eventually we find that the $1,000,000 deposited in A Bank results in an additional $9,000,000 of money that is nothing but debt. But remember where it came from in the first place. The government either borrowed the original $1,000,000 or simply asked the Fed to create it. Thus we have $10,000,000 of money that was created from nothing and is backed by nothing but debt. This is pretty cool. It seems to me that if one really wants to “make money” in his life time, he should do whatever it takes to become a central banker or simply a high level officer in any bank that is part of the Federal Reserve System.
I wonder if there is a name for a system of interest in which one group of people gets paid for simply creating money from nothing? Thomas Edison summed up the immorality of the system when he said:
People who will not turn a shovel of dirt on the project nor contribute a pound of materials will collect more money…than will the people who will supply all the materials and do all the work.
[ As quoted by Brian L. Bex in The Hidden Hand (Spencer, Indiana: Owen Litho, 1975)]
Let’s consider the purchase of a $200,000 home in which $60,000 represents the cost of the land, architect’s fee, sales commissions, building permits, and so on and that $140,000 is the cost of labor and building materials. If the home buyer puts up $40,000 as a down payment (20%), then $160,000 must be borrowed. If the loan is issued at 7% over a 30-year period, the amount of interest paid will be $223,214. The amount paid to those who loan the money is about 1.6 times greater than that paid to those who provide all the labor and all the materials. It is true that this figure represents the time-value of that money over thirty years and might be justified on the basis that a lender deserves to be compensated for surrendering the use of his capital for half a lifetime. But that assumes the lender actually had something to lend, that he had earned the capital, saved it, and then loaned it for construction of someone else’s house. What are we to think about a lender who did nothing to earn the money, had not saved it, and, in fact, simply created it from nothing? What is the time-value of nothing?
An interesting aspect of creating money from nothing is that as the loan is paid off, money is destroyed or rather simply disappears. Let’s see how this works. The bank creates a note when it leds the money. The note is an asset and the bank notes are a liability. It’s worth noting that the bank notes are not much of a liability because the banks need not redeem the bank notes in anything of value. Remember, this is a fiat money system. The Federal Reserve Notes we use as money are not backed by anything of value. If the depositors at any given bank should become concerned about the credit worthiness of their bank, there are two mechanisms that provide a safety valve.
The first mechanism is the Fed itself. Every bank that is a member of the Fed system (there are very few which are not) is guaranteed to have funds made available to it on extremely short notice. Thus in times past, before the Fed existed, if the depositors in a bank became concerned about the bank’s financial condition, there were “runs” on the bank. Of course, bank notes at that time were worth something because each bank was required to redeem its notes in gold or silver coin. But now our dollars are simply pieces of paper–this is our money. Still, a number of depositors might be concerned about their money. This happened at the Great Northern Bank in England just last year. There were lines running out into the street with individuals trying to get their cash. This might happen because with a fractional reserve system, each bank will have only perhaps 10% of the cash on hand versus claims on that cash. But the Fed provides a system for any bank which might experience this problem. The Fed simply supplies the funds needed to the member bank on a short term basis until the depositors are reassured there is no problem.
The second mechanism is the Federal Deposit Insurance Corporation (FDIC). This is another government agency that insures the accounts of bank depositors. Up until last year, each depositor was guaranteed up to $100,000 in a given bank. During the financial crisis last year, to help ease the concerns of depositors, the government increased this limit to $250,000. The banks all contribute funds to the FDIC so that if a bank should fail each depositor will get all of his money as long as the total does not exceed $250,000. If many banks fail in a short period of time that might put a strain on the FDIC reserve funds, the US government has guaranteed that it will provide the funds necessary. The FDIC plays a role when individual banks mismanages its assets and liabilities. If the bank made too many bad loans and kept these loans on its books, then the FDIC will step in. The FDIC will close the poorly managed bank and transfer the deposit accounts to “supposedly” a more trustworthy bank. The FDIC uses its reserve funds to provide the difference between the bad bank’s assets versus liabilities. So as long as an individual depositor’s funds do not exceed $250,000, his money will simply exist in an account created in his name by the bank named by the FDIC to take over for the failed bank.
But going back to the earlier point that as debts are paid, the money created by the debt disappears. Let’s see how that works. Lets say someone takes out a loan for $10,000 for a year at 9%. The bank simply creates an account or places the money in an existing account in the borrower’s name. The borrower spends the money and the plan is to pay it back at the rate of $909 per month about $80 of which is interest. The note which the bank holds is an asset and the bank notes issued to the borrower are a liability. [As discussed above, it not a real liability because the bank has no real obligation to redeem the loaned out notes with anything of value.]
The borrower starts into his payment plan but he is struggling to make his payments. He decides to take on another part time job to help. The bank wants its floors cleaned and waxed each month and it has an extra $80 coming in each month. The borrower agrees to clean and wax the bank’s floors for $80 per month. So as the borrower makes his monthly payments, the value of the note decreases at the same rate that the liability of the bank notes decreases. The payment of the note in effect extinguishes the dollars created by the debt. But the interest does not just disappear. In effect, the bank bank got its floors cleaned and waxed each month for nothing.
This is the essence of creating money from nothing. By doing almost nothing of any value, the bank was able to get work done on its behalf by the borrower. This is the way the system works. It is a very sophisticated form of serfdom. Because the private bank cartel controls our monetary system, all of us who are forced to use this money are supplying free labor. In the simple example used, the borrower worked directly for the bank. But obviously it does not work this way in normal circumstances. But the net effect is exactly the same. The creator of the money gets the benefit of the exchange value of labor of the borrower.
Ain’t life just grand–for some folks, especially those at the top of the economic barrel.
In Part 5, I explained how most of us had been seduced into giving up our gold backed money for the pure paper money issued by the Federal Reserve Bank. Actually, I’m quite sure that no one reading this has any memory at all of gold coins or gold backed money since the gold confiscation scheme occurred in 1933. However, some may recall that silver coins were still used until 1964. That is when the LBJ administration stopped producing 90% silver coins. Kennedy half dollars continued to contain about 40% silver for a few more years but that’s it. I can recall seeing a few silver dollars when I was a kid but they were rare even then in the late 40′s and early 50′s. What’s the point? The point is that the generations born after say 1950 have no recollection of using anything but paper money. When paper money is all there is and it at least appears to work, then what’s the beef?
But that is the problem; it is all just appearance. “It” just appears to work. Behind the scenes, where the government does not want us to look, see and understand, it does not work. It is all smoke and mirrors–a house of cards that must inevitably collapse. But lets continue with the story I had started.
At the end of WW 2, Bretton Woods was in place. The US was Numero Uno, hands down, no contest, no one else was even close. The US possessed the worlds largest stash of precious metals, over 20 tons of gold and over 8 billion ounces of silver. Other than the fact that our economy had been directed toward the war effort, our industry was virtually untouched by the war. The US began producing for its citizens and for other nations. The US GDP consisted of about 70% production. Made in the USA meant you had a quality product in your possession. Anyone reading this who is my age will remember when in the 1950′s “made in Japan” was an indication of an inferior product. The only things we bought which were made in Japan were cheap things, trinkets and such forth which we didn’t care if they lasted for very long. When the Honda Civic was first offered in the US, it was considered a cheap car, just barely acceptable for transportation. Ditto for the German Volkswagen. The good things, the big ticket items were made at home in the USA.
There are many factors which influenced the changes which have occurred since 1945 but this topic is about gold and money. I’m trying to stay on this topic for now and plan to go back later to fill in some blanks.
You may recall that there was a G-20 meeting recently in Pittsburgh, PA toward the end of September. The essential purpose of this meeting was to whitewash the global reactions by governments and central banks in response to the financial crisis of September 2008. A careful reading of the statement issued by this group of 20 nations will reveal just two important points. First is that governments did collectively intervene starting in late September 2008 after the Lehman collapse to prevent a much larger world financial collapse and to re-invigorate world wide economic growth. The second point made is that it worked. The collective intervention of governments and central banks did prevent the collapse and the world economy is on the virge of new growth. The concluding memorandum said in other words, ”Just trust us, we’ve got your back!”
If this is your own feeling, especially if you trust the US government and the Federal Reserve Bank to get the US economy back on track, then you are most likely going to be disappointed. If you rely on the typical financial gurus to guide your investment portfolios and prepare you for retirement, you are going to be “sadly” disappointed.
But why did we need to convene the G-20 (at great expense, I might add) in Pittsburgh to tell us these two things? I mean, after all, after August 1945, it was the G-1, the United States, Numero Uno, we were in charge. How did we lose it?
As I mentioned in Part 5, we had agreed to the use of our dollar, backed by gold at the exchange rate of $35 per ounce, to serve as an international exchange currency. This was the seal of approval. As long as we could continue to redeem dollars for gold at the agreed upon fixed rate, world wide exchange was not just possible but was, in fact, conducive to economic growth. Everyone used dollars and these dollars were “as good as gold.” Everyone could rely on excess imports being paid off with dollars which could be converted into gold any time a nation had more dollars than it needed.
The problem was that the US was not actually keeping its part of the agreement completely intact. Bretton Woods made the US dollar the reserve currency of the world. This meant that dollars were needed by all nations to settle their balance of payments. But since the US could simply print dollars, settling the balance of payments for the US did not require more production and more exports, all that was needed was more dollars. In the aftermath of WW 2 and into the 1950′s, the excess of dollar creation was quite limited. It’s true that as a country we had embarked on a program of living beyond our means but it was not a blatant or excessively expanded standard of living. The US welfare state had begun but its primary features were a social security system, some limited unemployment compensation and some other still relatively small redistribution schemes like farm subsidies. The funded US debt increased a measly $70 billion between 1945 and 1965. Since the US funded debt has just increased about $1.88 Trillion dollars between 9/30/08 and 9/30/09, it’s clear that excess money printing was quite contained in the early years of Bretton Woods.
After President Kennedy was assassinated, LBJ took over and quickly began expanding the war in Southeast Asia. Then in 1964/65 the Great Society programs were introduced. Taxes on Americans could not be increased enough to cover the added costs without the creation of a backlash from the US population. Thus, now the incentive to crank up the printing presses was greatly encouraged. At the same time, the economies of our allies were gaining strength. Under de Gaulle, the French economy was doing quite well. In addition, de Gaulle was a hard money individual. He began to suspect that the US was using the preferred position of the US dollar to take advantage of other nations involved in international trade. Thus, since France was running a positive balance of payments surplus, he began taking the excess dollars France possessed to the US to get gold as required by the Bretton Woods agreement. A few other nations began doing the same thing.
In the late 1960′s, the US began meeting with England and Germany, as they were our two main allies most closely aligned with US views in the post war period, to establish procedures and policies to maintain confidence in the international trade agreements. Thus, Numero Uno became the G-3. The financial dominance of the US had begun its journey down hill. The US actually had several viable options in 1969/70. First it could just stop printing excess dollars and start living within its economic means. Second, it could do option 1 at a slow pace, slowly devaluing the dollar until it reached parity with the “price” of gold which many estimated to be about $100 per ounce at the time. Third, it could choose to ignore all the warnings and continue on a course of profligacy, spending more than it produced and exported, thus forcing ever more dollar creation.
Nixon was elected in 1968 and moved into the White House in January 1969. So we went from a Democrat president to a Republican president. The fundamental economic and financial policies did not change. No one would stand up to say “We are spending too much money!” Because of the Bretton Woods agreement, the US was bleeding tons of gold to foreign nations who were redeeming their excess dollars. By 1971 the US gold holdings had been reduced to only about 10 tons; Nixon and his advisors realized they could not keep redeeming gold at the current pace for very long. His administration tried to implement some wage and price controls which was not effective because markets, even when they are interfered with by governments, are more powerful than governments as discussed earlier. Then Nixon took the step of unilaterally abrogating the Bretton Woods Agreement in August 1971. The drain on the US gold holdings stopped but the excess spending did not.
But now there was a new dynamic at play, a situation which had never at any time existed in all of the previous recorded history of man. Since the world had been converted to a dollar standard and every government in one form or another, working with its central bank, had removed the idea and reality of gold as money, the entire world market was now just one big floating casino. Under both the gold standard and the gold exchange standard (Bretton Woods) each currency could be valued against gold and thus valued against each other. Now for the first time ever, no currency, no monetary system in the world had any connection to gold. In the past during times of crisis, war and upheaval, individuals could find some way to protect themselves financially. They could move their wealth to other currencies tied to gold or into gold itself. Because gold had been and continues to be much maligned by politicians, bankers and even investment brokers, gold is no longer regarded as money or even (by a very large segment of the population) as a valid investment vehicle.
We have answered the question posed by the title of this on going series of comments. Gold = Money? Emphatically, NO! There are still more pieces of information that need to be filled in so we must press on.
I am not going to catalogue them all, but all of the financial disturbances and economic calamities that have occurred since 1971 can be laid at the door step of eliminating the gold standard or any substitute which even resembles such a standard to keep money honest. Paper is not honest money, gold is honest money. Paper money can be easily created and manipulated; this is the reason that central banks and governments have been slowly moving individuals to accept paper money rather than honest money.
The Rothschild family has a long history of banking in Europe. This family established branches in England, France, Spain, Germany and Italy. They helped to finance many of Europe’s wars. One of the patriarchs of the family, Meyer Amschel Rothschild, is often given credit for this quote or some variation of it:
Permit me to issue and control the money of a nation, and I care not who makes its laws.
If you are not familiar with the Rothschild name or the family history, I strongly suggest spending a few minutes with a Google search. Wikipedia probably has the most concise set of data, but data on the whole family is easily assessable.
Going back to the primary thread idea of this set of comments, the period of time following Nixon’s action in 1971 was a period of financial turmoil as nations sought to establish relative values for their currencies. Remember that nations still are trading with each other. Even though no nation could now get excess dollars turned into gold, they continued to use US dollars as the reserve currency. The US made a strategic decision in the early 1970′s by making an important bargain with Saudi Arabia. The arabs agreed to accept only US dollars in payment for their oil and in exchange, the US agreed to provide strategic military protection to the Saudi government and its oil fields. This agreement helped to set the post Bretton Woods period into a de facto Bretton Woods with no gold backing. Instead, the world currencies were allowed to float in value against each other on a daily basis and the US dollar continued to be the vehicle used to settle accounts. The bank for International Settlements (BIS) helped to sort out the arrangement but since 1971, trading has become very often a roulette wheel. Since currencies float, it is difficult to know for sure that the balance of payments are being correctly compensated when US dollar exchanges are made.
Another insidious feature of this system is that some nations may find it advantageous to slowly lower the value of their currency to enhance their exporting ability. In 1975, the first big inflationary bout arising from Nixon’s 1971 action began to unfold with a wold wide rash of inflation. The G-3 was expanded to the G-6 with the addition of Japan, France and Italy. The goal of the G-6 was to give international prestige and cover for the continued monetary excesses. By now, all nations were involved in creating excess paper money. Some printed lots more than others. In 1976, Canada was added to create the G-7 thus continuing to dilute US financial control. But the mission of the group remained the same: convince people around the world that central banks and governments are in control and there is no need to fear. The BIS and the International Monetary Fund (IMF) are doing the work required (under supervision of the G-7) to keep international finances on an even keel even though some perturbations occur from time to time. But on the inside, excess money was still being created by virtually all governments and their central banks so the real situation continued to deteriorate.
Through the rest of the 70′s and for most of the 80′s there was currency crises or a banking crisis or an economic crisis just about every year. In the US, a serious crisis occurred in 1979 and continued through to 1981. Gold hit $850 per ounce (even though gold was not money) and interest rates exceeded 20% for a period of time while the stock market slumped. In 1987, there was another major stock market crash. Just about every country had some type of problem. The G-7 acted as a united front to keep up the façade that everything was just A-okay. The collapse of the Soviet Union in 1989-1990 provided a nearly two year respite before the financial problems continued displaying themselves. In 1994, Russia was granted observer status to the G-7.
In 1997, Russia was added to the group to create the G-8. But this time there was a major difference. Russia was not a major world trader at the time so why should they be invited to join the exalted group who influence and monitor world trade activity? What had happened was that Russia announced it was in default on its sovereign debt. This sent perturbations around the world. A nation that announces that it can’t pay its debt throws fear into the hearts of traders and financial markets everywhere. If one nation is in default, others could be also. This lion had to be tamed. Russia joins the group, the prosperous nations are in control. The crisis abates and markets are stabilized yet again. The façade continued.
The past decade has continued with constant financial disturbances, some of them quite noticeable. Obviously, 2007 and 2008 were two of the more notable years. And now, if you are following this, the recent G-20 meeting I mentioned toward the beginning of this section comes back into play. The G-20 has been around for a few years, actually since about 1999 when it met with regard to the Asian monetary crisis. Still, its meetings were limited to the finance ministers and central bankers. Heads of state of the G-20 were not involved until November 2008. The heads of state met again in the spring of 2009 and now they have recently concluded their meeting in Pittsburgh. But the Pittsburgh meeting marks a new level. The G-8 has been superseded by the G-20. The statement issued by the G-20 clearly indicates that this expanded group of nations will continue to collude in the future as the G-8, G-7, G-6, G-3 and Numero Uno have done in the past to insure that the façade of safety and security of the international financial system is maintained. As I said at the beginning, this is smoke and mirrors, it is not reality. Danger lurks and we cannot be sure what events the next dawn will bring. Stay alert. Read the news headlines but be aware that what you are seeing in the news is probably not the reality. Federick Bastiat is famous for remarking about the difference between that which is seen and that which is not seen.
The problems created from many years of excess money production have not gone away. Again, there is more to discuss but since we have answered the question “Gold = Money?”, perhaps it is time to change the title.
The creation of western style, government established, central banking cartels was the key to gaining control of a nation’s monetary system. But as long as a gold standard was in place, any central bank was limited in its ability to create debt money. The US was the last major hold out. The Federal Reserve Act was approved on December 23, 1913. Most members of Congress had already left Washington for the Christmas recess but a cadre of select members remained. These members were enough to form a quorum and were supporters of the central banking system. So, in essence, it was one of those dark nights with no discussion to ever see the light of day that allowed the Federal Reserve to come into being. However, not every one was sleeping at the time. There were a few who did understand what was being done.
Here are three quotes on the Federal Reserve Act bill of 1913 from Congressman Charles A. Lindberg, father of the famous pilot.
“This Act establishes the most gigantic trust on earth.…When the President signs this Act, the invisible government by the Money Power, proven to exist by the Money Trust Investigation, will be legalized.…The money power overawes the legislative and executive forces of the Nation and of the States. I have seen these forces exerted during the different stages of this bill.…”
“The new law will create inflation whenever the trusts want inflation. From now on depressions will be scientifically created.”
“The new law will create inflation whenever the trusts want inflation. It may not do so immediately, but the trusts want a period of inflation, because all the stocks they hold have gone down… Now, if the trusts can get another period of inflation, they figure they can unload the stocks on the people at high prices during the excitement and then bring on a panic and buy them back at low prices.…The people may not know it immediately, but the day of reckoning is only a few years removed.”
The most significant event to occur in 1914, the year following passage of the federal reserve act, was the start of WW 1. Almost immediately, the countries involved were short of funds to pay for their respective war machines. As a consequence, one of the early acts by every involved European government was to authorize the central banks to suspend convertibility. But just what does that mean? Well, remember from our earlier essays on the topic that gold (and silver) became the most marketable commodity and therefor the free market choice of millions of individuals to serve as money, the medium of exchange. But this medium of exchange or money in reality was owned by the individuals in an exchange. One person gives up the product he has produced and in return he receives a certain amount of “money” which was gold (or silver). He does not need that money right away so he takes it to the bank for safe keeping and is given a receipt. The paper receipt requires that the holder be given the specified money or gold on demand when the receipt is presented at the bank. That is convertibility.
Now the central banks had a much extended ability to create debt money. They could create money from nothing and loan this money to the government at a specified rate of interest. The government can now use the money to purchase those materials needed to conduct the war. As this new debt money (fiduciary media) makes it way through the markets, it passes into the hands of millions of individuals who make exchanges in the market. But now when an individual takes this money to the bank, the bank has no legal requirement of convertibility–that is, it does not have to redeem the paper notes for gold. Thus there is very little limitation on the bank’s ability to create money. Most central banks did and still do establish limits on money creation. For example, today in the US, the Fed requires its member banks to maintain a 10 percent cash reserve, but this reserve requirement is nothing but bank notes, not actual gold or silver specie.
Historically, when there had been a war, there was almost always a noted increase in prices due to inflation of the money supply followed by a return to close to prewar levels as the excess money creation stopped at war’s end. But at the end of WW 1, for the first time there was a difference. The governments never bothered to repeal the acts which authorized the suspension of convertibility. In effect, what took place was that the privately owned (by millions of individuals) money (gold and silver) had been confiscated. The central banks were simply allowed to keep this money.
In the US there was a different situation. The US entered the war several years later. Its debt requirements were not as severe as the European nations and there was a historical system of gold and money that the government knew would be quite difficult to overcome. Americans had a history of much greater individualism and independence than the typical European citizen. Convertibility was not suspended and gold continued to be used by individuals. However, that did not prevent the Federal Reserve Bank from following a scheme of monetary inflation throughout the “Roaring Twenties.” Murray Rothbard in his book “The Great Depression” documents precisely how and why the Fed continually inflated the money supply from 1921 until 1928. The book discussion is much too long and complex to be summarized here but I recommend reading this book, especially the first half to gain an understanding of Fed and government activities during these years.
The money inflation led to malinvestment in capital stock and excessive speculation in the stock markets. The crash followed in 1929 and the depression set its hooks with great help from the Hoover administration which tried to maintain high wages and high prices created by excess money by cajoling business owners and adding government subsidies. This set the stage for FDR.
FDR campaigned against Hoover, claiming that Hoover was spending excessively trying to create growth by dumping money into the economy. After winning in a landslide election, FDR declared a bank holiday–he ordered all the banks closed. Upon reopening the banks he told the nation that too many Americans were hoarding their gold rather than using it in the markets. This was actually true. The average person recognized that gold was more valuable than paper money because as time progressed the paper was able to purchase fewer goods in the market. It was a clear example of Gresham’s law–bad money chases good money out of the market. That is, as the paper money came into an individual’s possession, that individual recognized that it was better to spend it immediately and purchase almost anything. The almost anything purchased was more like to retain value into the future than the paper money. But everyone realized that the gold would continue to purchase the same amount of goods today, tomorrow or even years into the future.
But individuals saving (hoarding as FDR called it) their own property, their money, their gold for a rainy day in the future was not the cause of the depression. Creating too much credit money in the first place was the cause and creating more credit money from nothing and providing subsidies and government interference in the market to support high prices and high wages was not the solution. But FDR seductively convinced most Americans with his fireside chat that they would all help relieve the depression by turning in their privately owned gold to the treasury. They would all be reimbursed at the then government established rate of $20.67 per ounce. Of course there was also a penalty of a $10,000 fine and/or a ten year prison sentence for those caught not turning in their privately owned gold like good little sheep. You can be sure that there were some who were smart enough to recognize what the truth was and did not turn in their gold but the majority did as they were told. Americans were given a number of months to turn in their gold. A few days after the grace period ended, FDR unilaterally had the Treasury devalue the dollar from $20.67 per ounce to $35.00 per ounce. This amounted to an almost 70% devaluation of the dollar. All those Americans who had obeyed the new law essentially had just been legally embezzled by their own government. Actually, all Americans who held paper dollars or worked for paper dollars were affected, not just those who turned in their gold and were given paper dollars in exchange.
But now the stage had been set. Remember that free markets are simply millions of people making voluntary exchanges using that commodity which most of them recognize as the most marketable or desirable commodity. The actual money that free markets had been using for many centuries had now been taken away from the vast majority of individuals. It is true that some individuals still had gold but gold was starting to function less and less as money simply because it was not available. When FDR using the War Emergencies Act of 1917, confiscated all privately owned gold, he also issued directives that canceled all contracts which required payment in gold. There were many intelligent people who recognized long before 1933, even before 1913 that banks sometimes issued bank notes in excess of the actual amount of gold stored in the vaults. Thus some of these people were smart enough to require payment in gold specie at the end of a contract to insure that they would receive the full value of the payment expected and not some lesser or discounted value because some bank notes could not be trusted to maintain their full value throughout the lifetime of the contract in question. So not only did FDR essentially steal privately owned property, he also broke the law by destroying legally valid contracts.
After 1933, while very few individuals world wide owned gold or had access to it, central banks and the governments behind the banks still used gold to settle international accounts. This system was formalized in 1944 at Bretton Woods, NH. WW 2 was winding down. The allies on the winning side gathered at Bretton Woods to discuss how to conduct international economics when the war was over. The US was the only major combatant to end the war relatively unscathed by its ravishes. It had the strongest economy and was the mightiest military power in the world. In addition, because of its mighty industrial economy, it had managed to collect the largest holding of precious metals of any country. The allies agreed that the US dollar would be used to settle all international balance of payments. That is, as nations trade with each other, very seldom does one nation have an exactly even exchange with another. Under a gold standard, the nations would periodically use gold to settle the outstanding balance. Under the Bretton Woods Agreement, the US dollar would be used to settle these balances and the US promised to redeem any excess dollars a nation might accumulate beyond their trading needs at the rate of $35 per ounce of gold. This system is known as a gold exchange standard because gold is not used directly in international settlements but rather acts as a counter balance to the use of the paper currency.
Remember that the definition of inflation is the creation of excess money beyond the ability of banks to redeem that currency with anything of real value. Thus, while a nation can still inflate its own currency, the international settlements system kept a lid, of sorts, on a high rate of inflation. This is (or rather was) true as long as the US continued to redeem US dollars for gold at $35 per ounce.
In the post WW2 economy, as the world began recovering from the war,all nations began rebuilding. In the US, which had continued a depression like economy during the war, there was a tremendous burst of economic energy because so many families had large savings accounts. The savings had been accumulated during the war simply because of rationing and the fact that the government had directed the nation’s industry to the war effort. There were very few products available on the market for people to purchase, rather mostly just necessities were available. Now the companies that during the war had produced tanks, airplanes, artillery pieces and guns could convert their machines back to producing cars, washers, dryers, refrigerators and stoves. It was, especially in the United States, a period of confidence and great expectations.
Money did not seem to be a significant problem to the average individual. Of course, each person always wanted more but the Federal Reserve Notes that were circulating throughout the country seemed to function just like the dollars (which used to be backed by gold or silver) that had always been used in the past. It seemed that the only difference was that an individual could not take these notes to a bank and get them redeemed into gold. But since they could be used to purchase anything one desired in the market place and prices were rising at a very slow, almost imperceptible pace, they even seemed to be retaining value over time.
This is how, at least in the US, the population was tricked into giving up their gold money and were converted into users of paper money. Clearly, this is not the end of the story–more yet to come.