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.