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Separating Money and the State, Part 1: Eighty Years of Destruction

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On December 23, 1993, the Federal Reserve System marked its 80th birthday. But few were celebrating.

The Federal Reserve Act, which was signed into law in 1913 by President Woodrow Wilson, is described by economist Hans Sennholz as “probably the most tragic blunder ever committed by Congress.”

According to the Federal Reserve’s Board of Governors, “The function of the Federal Reserve System is to foster the flow of credit and money that will facilitate orderly economic growth, a stable dollar, and long-run balance in our international payments.”

The results have been the exact opposite. The government’s money and banking monopoly has created an unstable modern American economy, while only serving the political and bureaucratic needs of the federal government.

The Federal Reserve’s worst crime is its decimation of the dollar. The buying power of the dollar has shrunk 99 percent since the Fed’s creation in 1913.

The idea of having a central bank in America waxed and waned during the 19th century. But, as Wall Street analyst and historian James Grant wrote, it took the Panic of 1907 to produce “a critical mass of disillusionment with the financial system as it was.”

A run on New York’s Knickerbocker Trust Co. sparked the panic. Knickerbocker’s president had invested heavily in the stock of United Copper Company. When United Copper’s price collapsed, the 18,000 Knickerbocker depositors wanted their money back.

The Knickerbocker failed, and nervous depositors at other trust companies demanded their money, setting off a panic. Chase National Bank economist Benjamin Anderson described the Panic of 1907 as “almost purely a money panic” that had “pulled us up before the boom had gone too far.”

Pierpont Morgan came to the rescue in November 1907, orchestrating a deal that saved the trust companies. But, as author Ron Chernow wrote in The House of Morgan : “Everybody saw that thrilling rescues by corpulent old tycoons were a tenuous prop for the banking system. Senator Nelson W. Aldrich declared: Something has got to be done. We may not always have Pierpont Morgan with us to meet a banking crisis.”

That “something” began to take shape three years later when J.P. Morgan partner Harry Davison called together other key Wall Street bankers for a “duck-shooting holiday” at the Jekyll Island Club off the Georgia coast.

The ducks were safe, because Davison and company spent their time inside devising a central-bank plan calling for regional reserve banks to be supervised by a board of commercial bankers.

Using this plan as a blueprint, Senator Aldrich introduced his central-bank bill to Congress. The first time around, the Democrats blocked it.

The Jekyll Island plan reappeared in 1913 when Democratic Congressman Carter Glass from Virginia used it as the basis for the Federal Reserve Act.

New York Republican Senator Elihu Root argued against the bill for three hours on the Senate floor. In Money of the Mind , James Grant wrote:

He [Root] warned against the reduction in bank reserves and against the certainty that, following the inevitable inflation, foreigners would sell American securities [dollars]. Root was more farsighted than he could have known. The dollar crisis to which he alluded was fifty years away, and the first recognition of the loss of the government’s creditworthiness was even further off in the future.

Root’s arguments fell on deaf ears. The Federal Reserve Act was passed. The bill’s final version called for the twelve private regional reserve banks to be supervised by a Washington board to include the Treasury secretary and presidential appointees.

Although the Act describes the twelve reserve banks as “private,” this is a misnomer. The Federal Reserve’s officials are appointed by the government, and the banks are forced to own the Federal Reserve by government statute. As economist and historian Murray Rothbard has observed: “The Federal Reserve Banks should simply be regarded as governmental agencies.”

Carter Glass described the Federal Reserve as “an altruistic institution,” that is, “a part of the Government itself, representing the American people, with powers such as no man would dare misuse.”

History has proven that Congressman Glass was, at best, naive.

A government-controlled central bank was just a part of the government’s encroachment into the economy. As Rothbard has noted: “Control over a nation’s money is a prerequisite for dictation over the rest of the economy.”

To gain passage of the bill, the pro-Fed forces promised to preserve the gold standard. However, this promise soon withered.

Reserve requirements were quickly reduced, and an immense explosion in bank credit ensued, with the bubble finally bursting in 1929 with the great stock-market crash.

By the 1930s, members of the public realized that the Fed was creating more and more dollars, and they began to take their dollars out of banks, converting them to gold. With banks only keeping a nickel for every dollar, cash reserves were at very low levels.

In 1933, the dearth of cash reserves led to the declaration of bank holidays throughout the country. The banks could not pay depositors their money.

The banks were reopened, but, as Benjamin Anderson explained: “Blanket authority was given the President [Roosevelt] to do pretty much as he saw fit regarding money and banking, including authority for the seizing of the gold and gold certificates in the hands of the people.”

When people began protecting the value of their savings by converting to gold, Roosevelt retaliated by taking away that option. Even Carter Glass was appalled, telling the President: “It’s dishonor, sir. This great government, strong in gold, is breaking its promises to pay gold to widows and orphans to whom it has sold government bonds with a pledge to pay gold coin of the present standard of value. It’s dishonor, sir.”

Senator Thomas Gore from Oklahoma was more succinct: “Why, that’s just plain stealing, isn’t it, Mr. President?”

FDR then enacted the Gold Reserve Act, which took gold from the Federal Reserve banks, giving it to the United States Treasury. He then devalued the dollar by 41 percent, setting the price of gold at $35.00 to the ounce.

With control of the money supply essentially in government hands — and government freed from the confining gold standard — World War II could be financed by the Federal Reserve.

From June 1939 to May 1945, the amount of money in circulation grew from $7 billion to $26 billion, a 271 percent increase. Commercial-bank demand deposits and U.S. government deposits increased 210 percent from June 1939 to December 1944.

In mid-1944, the Bretton Woods monetary conference was held. The Bretton Woods system called for the dollar to be convertible into gold at $35 per ounce. But only foreigners — and eventually only foreign governments — were allowed to convert dollars into gold. All other currencies were defined in terms of dollars. Thus, the dollar was treated as gold.

But the Federal Reserve could create dollars much faster than gold could ever be pulled from the ground.

In the 1960s, President Lyndon Johnson needed money to pay for both the Vietnam War and his Great Society programs. And the Fed accommodated.

Predictably, foreign governments began to see that as the Fed created more money, the dollar was overvalued at $35 to the ounce of gold. They began trading their dollars for gold. The U.S. supply of gold fell from 701 million ounces in 1949 to 296 million ounces by March 1968.

In the summer of 1971, the run on gold accelerated. In August, more than five billion dollars in gold and reserve assets were emptied from the Treasury in less than two weeks. On August 15, with only $2.23 in gold available to redeem every $100 of U.S. paper promises, President Nixon declared international bankruptcy by closing the gold window. After that Sunday, as former Congressman Ron Paul and Lewis Lehrman have explained: “There were now absolutely no checks on the ability of the United States to inflate.” And inflate the Fed has. By all measures, the money supply has increased by 400% since 1971.

The period since 1971 has been one long, continuous inflation. The general price level, as measured by the implicit GNP deflator, has quadrupled in the 22 years after Nixon closed the gold window.

The consumer price index increased by only 10 percent in the 67 years prior to the Federal Reserve’s creation in 1913. It has increased 625 percent during the 67 years since then. In 1833, 80 years prior to the Fed’s creation, the index of wholesale commodity prices in the U.S. was 76.2; in 1913, it was 80.7 — a six percent increase. In November 1992, the wholesale index stood at 827.77 — a tenfold increase.

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    Mr. French is vice president of a bank in Nevada and has taught economics at the University of Nevada at Reno.