Wednesday, September 23, 2015

Howard S. Katz. The Paper Autocracy. 02. Paper Money. Books in Focus. 1976.

Chapter II: Paper Money
There are two kinds of people in America today — those who have the privilege of creating money and those who have the obligation to accept it. The privilege of creating money is given to a special elite, those who own or control banks. Since it is illegal for an outsider to go into the banking business, those already in that business have a special privilege in law denied to the rest of the people. You can best understand how money operates in our modern world — how bankers profit from the system without producing any wealth, how they exploit the working people of the society, and why they have come to have special privileges in law — by examining the history of how paper money came into being.
In England, prior to about 1660, there was no paper money. Money was gold or silver coin. However, this was not honest money. The King was in the habit of taking the gold which came in to him and shaving a little bit off from each coin and passing the new coins off as equal in value to the old. Alternatively, he would melt the coins down and dilute the gold with copper and mint new coins of the same sise but with less gold content. If people refused to accept these diminished coins at equal value with the original coins, then the courts (appointed by the King) would rule that the value of money came, not from the objective value of the metal, but from the declaration of the King; i.e., that the money was worth whatever the King, said it was worth.
These rulings by the kings’ courts were called legal tender rulings; that is, they determined just what could legally be tendered (given) in payment. The shaved or adulterated money was called fiat money because its value came from the fiat of the king.
As a product of the Reformation there began the widespread accumulation of wealth, and, starting after 1660, some people began to look for places of safekeeping. The practice started of taking one’s gold to a goldsmith and paying him a small fee to keep it safe. The goldsmith in turn would issue the owner of the gold a receipt, a small slip of paper promising to return his gold upon demand. The process was the same as baggage checking today.
But unlike baggage receipts, the gold receipts soon came to have a special use. If customer Charles wanted to make a purchase from merchant Michael, then what was the sense of Charles taking his paper receipt to the goldsmith, changing it for gold, and then coming back to make the transaction? It was easier for Charles merely to pay for the merchandise with the paper receipts. Then Michael could take these to the goldsmith and redeem them for gold, if he wished.
Of course, by the same logic, Michael found it easier to keep the paper receipts and use them to make his purchase from wholesaler William. As long as everyone knew that the receipts were redeemable in gold on demand, there was no need to actually redeem them, and it was more convenient to handle the paper receipts than the actual gold. In this way paper receipts for money began to circulate as money itself.
The trouble started when a goldsmith noticed: “Even though people have the right to redeem their receipts for gold at any time, in actual practice, very few of them do, and these are balanced off by new deposits of gold coming in. If I print up more receipts than there is gold, no one will know about it because it never happens that everyone comes in to redeem all at once. And since the receipts circulate as money, I will have extra money.” Beautiful.
And it sure beats honest work.
But the goldsmith didn’t quite get away with his scheme. It was too blatantly something for nothing. It required a rather subtle refinement. People objected when the goldsmith simply printed paper receipts to add to his own wealth. But they did not know what to say when the goldsmith printed paper receipts with which to make loans. By this act of lending, the ancient Goldsmith became a banker; this was the birth of modern banking.
When people objected to his printing up receipts for gold when he did not have enough gold to redeem the receipts, the goldsmith-banker would reply: “But I do not keep these receipts. I lend them out.” And the borrower would say: “And I do not keep the receipts. I employ them productively in my business. And then I pay them back.” And the goldsmith-banker would conclude: “And when he pays back the loan, I destroy the receipts.”
But what the goldsmith-banker has failed to mention is that he has profited from the interest on the loan. As William Paterson said in his plan for the creation of the Bank of England, “The Bank hath benefit of interest on all moneys which it creates out of nothing.” 1 This profit was unearned wealth, a gain made at the expense of the rest of the community, which lost what the banker gained.
Unfortunately, the people of this time did not understand interest. Economists and theologians, following the teachings of Aristotle and the Bible, condemned all interest as unearned wealth. But since interest was essential to the newly developing capitalist economy which was growing out of the feudal system, most people just looked the other way and said, “We’re going to do it anyway.” It was not until the development of the Austrian theory of money and credit by Ludwig von Mises that people could understand that interest was the price one paid for the use of goods over time, that everyone had a time preference and preferred to have goods right away rather than to wait for them. In simpler terms, a man who saves gives up something because be would prefer to consume his wealth immediately. The saver also confers a benefit to the man to whom he lends his savings because the latter can employ the capital which has been saved to produce additional wealth. Interest is the reward to the saver. It compensates him for his act of giving up, and it is a fair price for the borrower to pay for the use of wealth-producing capital.
But while this applies to real capital, which has been earned and saved, it does not apply to the paper receipts printed up by the goldsmith-bankers. They did no saving; they did no giving UP. Their interest represents what the medieval clerics thought all interest represented — unearned wealth. Since the people of the 17th century did not understand capital and interest, they were not able to distinguish between real capital and valid interest on the one hand and bank created “capital” and invalid interest on the other.
In the late 18th century it was common practice for a banker to print four times as many paper receipts as he had gold. This means that if a commercial banker received $1,000 in deposits, he was likely to print $4,000 in receipts. If his interest rate on loans was 7%, then he did not get 7% x $1,000 = $70; he received 7% x $4,000 = $280. His real rate of interest was 28%!
One of the real big-time bankers was the before mentioned William Paterson. Paterson got some friends together and raised 72,000 in gold and silver to lend to the King, of England, who needed the money to fight a war. But instead of lending him the money directly, Paterson formed a bank and printed up paper receipts to the tune of 16-2/3 times his gold and silver. He thus lent 1,200,000 to the King, and at an interest rate of 8-1/3% per year, received interest payments of 100,000 per year.2
Here was a man whose total capital amounted to 72,000, and his annual interest payments were 100,000. This was a real rate of interest of almost 140% per year.
But Paterson had gone too far. It was true that most of the people would circulate the receipts and not demand gold. But there were always a few people who would. And since Paterson had only 6% as much gold as he needed, rumors began to circulate that he could not make redemption. Thus, two years after his bank was opened people came to him in large numbers and demanded redemption of their paper receipts. Paterson could not pay. He did not have enough gold.
But Paterson had had the political foresight to lend his paper receipts to the government. Since the paper receipts were needed to fight the war, the government could not allow them to fail (as happened to other goldsmith-bankers of the day). Paterson’s paper receipts were declared to be legal tender. They were held by law to be just the same as the gold for which they had stood. Thus was born a new kind of fiat money-paper money.
The old fiat money had been adulterated metal, for example, 50% gold and 50% copper which was declared by legal tender enactments to have the value of 100% gold.
It, at least, had the virtue of having partial value. But paper money has no objective value. Its total worth is declared by fiat and enforced by the power of the state. When people are left free to choose their own money, they choose a commodity of objective value. For reasons pertaining to the chemical characteristics of these metals, the most common choices are gold and silver. In order to get people to accept paper money government must force them to accept it by legal tender laws.
The first bankers had operated on the basis of fraud. They promised to redeem in gold more paper notes than they could actually redeem. They remained in business only so long as people did not ask them to keep their promises. But with William Paterson, we can see the basic elements which constitute our present aristocracy. The banker is constituted a special elite person; he is given the privilege in law of having his paper receipts declared to be legal tender money; and by this means, he acquires an unearned wealth.
This is the origin and basic essence of bank created paper money. However, the system has undergone a considerable evolution to arrive at its modern form. You have not been taught this in history class, but the major political issue which has occupied this country since its inception has been the issue of hard money, of objective value, versus bank-created paper money.
From the time of its discovery, paper money was extensively used in America, especially in connection with wars. Its most famous use was the Continental currency of the Revolutionary War. But after this currency had become worthless and the people had stopped using it, Congress sent Thomas Jefferson on an inquiry to create a currency for the new country.
Jeffers on reported that the people had already adopted a currency, the Spanish dollar (or piece of eight), a gold or silver coin in common use in the Spanish colonies. Congress then adopted this coin as the official money of the country, and, a few years later when the Constitution was written, prohibited the enactment of legal tender laws.
The liberal, equalitarian viewpoint of the Founding Fathers had led them to an extreme hard money point of view. But the bankers were not ready to give up. They had suffered a defeat with the establishment of an official gold/silver standard at the time of the writing of the Constitution. But they still retained the privilege of issuing paper receipts, called bank notes, far in excess of any gold or silver they had in their vaults with which to redeem them. Typically, bankers would issue more and more paper notes to maximise their profits. It was a matter of delicate judgement as to how many notes one could issue before the public would become alarmed and demand their gold. Periodically, the more greedy members of the fraternity would issue to excess. Then there would be a run on that bank’s gold; it would not be able to pay; and it would collapse.
The first attempt by the bankers to expand their power was Hamilton’s proposal for a central bank. A central bank is one along the lines of William Paterson’s institution. It is accorded a special status by the government, and its primary function is to make the government loans. Bankers found that a central bank offered them the following advantage. When a small bank got itself into trouble by an overissue of bank notes and suffered a run on its gold, the central bank would step in and lend the small bank gold to tide it over the run. Thus protected by the central bank, the small banks, who had previously expanded their note issue to three to five times their gold, now felt safe to expand it substantially beyond that, with correspondingly greater profits.
Jefferson, who understood the economic and political implications of banking, was, in principle, a foe of all bank note expansion. As he stated in a letter to Dr. Thomas Cooper on Jan. 16, 1814: “Everything predicted by the enemies of banks, in the beginning is now coming to pass. We are to be ruined now by the deluge of bank paper, as we were formerly by the old Continental paper. It is cruel that such revolutions in private fortunes should be at the mercy of avaricious adventurers, who instead of employing, their capital, if any they have, in manufacturers, commerce and other useful pursuits, make it an instrument to burden all the interchanges of property with their swindling profits, profits which are the price of no useful industry of theirs. Prudent men must be on their guard in this game of Robin’s Alive, and take care that the spark does not extinguish in their hands. I am an enemy to all banks discounting bills or notes for anything but coin.3” Jefferson was unsuccessful in stopping the banks in the practice of issuing notes in excess of their gold, but he decided to fight Hamilton on the issue of central banking, which allows a far greater expansion of note issue. This fight between the conservative forces, led by Hamilton, and the liberal forces, led first by Jefferson and then by Van Buren and Jackson, was the major political issue of the early 19th century (1791 to 1835). The Jeffersonian forces were ultimately successful when Andrew Jackson vetoed the extension of the central bank’s charter and was widely supported by the populace. However, the basic idea of the evil of bank paper, per se, had not been communicated so the nation wound up in the position of opposing central banking without really knowing why.
In addition to the use of notes, banking was refined another step with the system of writing checks (officially called demand deposits to distinguish them from savings or time deposits). Just as the banks could issue more notes than they had gold, so they could create more money in checking accounts than they had notes. Banking became a structure of pyramids. At the base was gold, the real money. On top of that were three, four or five times the quantity of bank notes printed on the assumption that only a few people would turn them in for gold. And on top of that were several times the quantity of demand deposits, created on the assumption that only a few people would cash in their checks for bank notes.
The structure of banking in three phases is shown in the charts on pages 12 and 13. Note that banking has always depended on creating money in excess of its cash. Modern bankers, however, have the advantage that for them cash is Federal Reserve notes. Thus their cash can be increased at the will of the Fed.
This explains the nature of banking as it developed in the 17th and 18th centuries. To relate this to our modern system of money you must understand three additional developments:

The establishment of a uniform national currency. By this act, passed during the Civil War, the notes of all banks were required to be standardised. (Also, Treasury bills, whose redemption later became the responsibility of the government, were issued.) It was the standardization imposed by this act which allowed the bankers to later claim that their paper notes were dollars. In legal and economic fact at this time a dollar was a quantity of gold (or silver). Modern Americans do not understand that a dollar was originally a unit of weight, like an ounce or a ton. (It was, in fact, 25.8 grains of gold, 9/10 fine.) The paper notes which passed in circulation were merely receipts for dollars. But when these notes became standardised, the bankers began to refer to the notes as dollars, a fact which ultimately eased the transition to paper money.
The creation of a central bank. In the year 1900, the country was solidly against the institution of a central bank, but as has been noted it was Jeffersonian in form without really understanding the essence of what Jefferson had been saying. A group of bankers were therefore able to put across the enactment of a central bank by sophisticatedly disguising it as a bank reform measure and then feigning opposition to their own proposal. This central bank was the Federal Reserve System (actually a system of 12 banks) created in 1913. The Federal Reserve immediately began to act very much like William Paterson’s original central bank. That is, it expanded the note issue and lent the money to the government to fight a war. The results were big profits for the bankers.
Two important differences between the creation of the Federal Reserve System and the creation of William Paterson’s Bank of England should be noted. Paterson created his bank in competition with and in opposition to the smaller private banks, and in fact the first rumors concerning the solvency of his bank were spread by jealous smaller bankers. But the Federal Reserve has never been in competition with American private bankers; it is controlled by the private bankers and is used to serve their interests. Also, Paterson found his war and took advantage of it. But the banking element which manipulated the Federal Reserve System through an economically naive Congress was a major reason for U.S. entry into World War I.

(3) The declaration of paper money as a legal tender. After the bankers had lent their notes to the Government to finance World War 1, they turned and lent to the business community, thus sparking the business boom of the 1920s. (The effect of bank paper in creating booms and depressions will be discussed in Chapters III and IV.) This note issue reached its peak in 1929 when the banks found themselves over extended and were forced to contract. In the period 1929-1933 there were runs on banks with people demanding their gold. These runs reached a climax with the bank holiday of 1933. At that time the Federal Reserve System did what William Paterson had done in 1696; it refused to redeem its notes for gold. The Government then declared bank notes of the Federal Reserve System to be a legal tender. This was the creation of paper money in the United States.4
In our present banking system the first pyramid is gone.
Standardised Federal Reserve notes have replaced the standardised private bank notes, and since the former are a legal tender, there is no need to back them with gold (although the nation still maintains a gold supply). However, the second pyramid remains, and the nation’s banks now expand their demand deposits on a base of Federal Reserve notes.
With the enactment of a legal tender law in 1933, the basic system was created which is now leading to the formation of an American aristocracy. The bankers and the Federal Reserve have, since that time, used their privilege to create a quarter of a trillion paper dollars. The interest which they have charged on this money represents wealth stolen from the American people. This is the basis of the system. It is to protect this income-producing privilege that the bankers are forced to expand their power and constitute themselves an aristocratic class.
In the early days of paper money, profiteers and adventurers arose who exploited the system for all it was worth. You will find the story of Andrew Dexter, Jr., as reported in the “Democratic Press” in 1809, an interesting example:

Each revolving year brings forth some extraordinary novelty to excite wonder and gratify curiosity. Long as banks have been in operation in various parts of the world, it was reserved for the present age, so fertile in discoveries and improvements, to invent the ne plus ultra of liberality. And accommodation in the tenor of a promissory note. And the most remarkable feature in this affair, is that the discovery was not made in London, Paris, Vienna, Philadelphia, New York, or Boston, but in a two-penny village, called Gloucester, in Rhode Island, containing about a dozen houses. In this village, immortalised by the invention, there was a bank established in 1805, of which the capital was composed of two thousand shares, of fifty dollars each, amounting to 100,000 dollars. Of this bank, Andrew Dexter, Junr. an illustrious speculator, borrowed the trivial sum of 845,771 dollars in their bank notes, for which sum he gave his promissory notes, without indorser, in the following improved form:

“I, Andrew Dexter Jr., do promise the President, Directors, and company of the Farmer’s Exchange Bank, to pay them, or order dollars, in years, from the date, with interest at two per cent per annum; it being, however, understood that the said Dexter shall not be called upon to make payment until he thinks proper; he being the principle stockholder, and best knowing when it will be proper to pay the same.

I annex the amount of the respective notes and the periods of payment, for the gratification of the reader:

With the bank notes received by Dexter for these notes of hand, there was carried on a stupendous scene of fraud and villainy. They were employed in the purchase of property of every kind, by Dexter and his friends: and as they made no scruple about price, they possessed’ themselves. of many of the most valuable estates in New England, some of which had descended from father to son since the first settlement of the country. Hundreds, perhaps thousands of people deplore their fatal credulity, which induced them to convert their property into this paper, not now worth a cent on the dollar, which has reduced them from a state of affluence to beggary and wretchedness.
The bank ceased its operations on the 27th of February, 1809, with the enormous sum of specie in its vaults of eighty-six dollars and fifty cents, which on accurate calculation, will probably pay a farthing in the hundred dollars to his creditors. The legislature of Rhode-Island at its last session appointed a committee to investigate the whole of the nefarious transaction. The committee has published a luminous report for the information of their constituents, from which this sketch is taken. 5
Such abuses outraged the public, and bankers realised that some limitations on their note issues were necessary if the privilege were not to be denied them altogether. Therefore, regulations were passed limiting the amount of notes a bank could print in relation to its gold. These regulations continue today except that today they limit the amount of demand deposits a bank can create in relation to its Federal Reserve notes. Abuses such as the above also show why banking has been limited to a special elite. If everyone could create money, then everyone would, and the system would break down.
Bank profits today thus depend heavily on the actions of the Federal Reserve. If the Federal Reserve issues more notes, then banks can use these notes as a base on which to expand their demand deposits, which they do in a manner similar to the ancient goldsmith by making loans. These additional loans brine, in additional interest, which is profitable for the bank. In our modern world the Federal Reserve is very important for the banks. It can make or lose them millions of dollars. The Federal Reserve in our modern society has the magical power to create money. It simply prints a note, and since its notes are legal tender, presto, it has created money.
In theory the Federal Reserve might print money for any purpose. The head of the Federal Reserve might go into a restaurant, order a steak dinner and then print up a Federal Reserve note to pay for it. But traditionally the central bank has existed primarily for the purpose of lending the government money. In practice the only time the Federal Reserve prints money is when the Federal Government runs a budget deficit and needs to borrow.
When the Federal budget is in deficit, the U.S. Treasury prints up pieces of paper called Government Bonds. A bond is nothing more than an IOU. Then the Federal Reserve prints up pieces of paper called Federal Reserve notes. A note is nothing but an IOU. Then these two agencies exchange IOUS. 6 But since the legal tender laws are deemed to have the magical power to make pieces of paper into money, presto, money has been created.
This is how the Federal Government borrows money in our present society. In reality our Government is bankrupt. The people do not have enough confidence in the Government to lend it money. Were it not for the Federal Reserve the Government could not borrow enough to meet the huge deficits it runs. But the important thing to understand is that every time the Federal Reserve creates money to lend to the Government, that money finds its way into the banking system. (That is, it is spent, goes into circulation, and is deposited in a bank.) Then it can be used as a base upon which to multiply the bank’s loans (demand deposits).
According to present regulations (depending on the type of bank) demand deposits can be increased by more than six times the cash base; thus, for every dollar printed by the Federal Reserve, the banks can create five times that amount in loans, receiving corresponding, interest payments.
Banks, therefore, have a vested interest (in more than one sense) in budget deficits. Since by far the biggest budget deficits occur during war, banks have a vested interest in war.

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