The Fed and Us

The Case Against the Fed
by Murray Rothbard
The Ludwig Von Mises Institute, 2007

If there’s a connection between opposing the federal reserve and believing in human biodiversity, it lies in the fact that people who question the conventional wisdom on one topic are more likely than the average thinker to do so on another. Finding out whether the partisans of hard currency are kooks or brave truth-tellers requires looking at their arguments.

Near the end of Murray Rothbard’s life he wrote The Case Against the Fed. His position was that government can not create wealth, it can only redistribute or steal. Also, the creation of the Fed was born from an unholy alliance between bankers and the state. Before explaining what the federal reserve does and going into its history I must explain some things about money.

Economics isn’t my specialty and so the discussion isn’t as thorough as it could be. Much is simplified or left out. Those unsure of something or interested can read Rothbard’s book for free here.

A Short History of Money

Man first began by trading. Somebody would get a fish and give it to a fellow tribesman for a spear. Unfortunately, this was very inefficient. Say Jones has a television but needs a hat, a pet goldfish and some eggs of equal value. The odds of finding another person with a hat, goldfish and eggs that will trade them for a TV is very unlikely. But let’s say that there is a divisible and almost universally desired commodity. In our example, it can be butter. Jones can trade his TV for a certain amount of butter, divide it up how he wishes and trade it to the egg vendor, hat dealer and pet store for what he needs. Some people may very well not have any use for butter themselves, but they will accept it knowing that they can trade it in the future to other producers who themselves will also realize the desirability of having the commodity. There is then a snowball effect, and butter becomes the generally accepted medium of exchange, or money.

Money doesn’t come into existence through government fiat or any kind of central planning. Different commodities have been used throughout history including sugar, salt, beaver skins, and tobacco in the Caribbean, West Africa, Canada and colonial Virginia and Maryland respectively. In German WWII POW camps cigarettes were used as money and traded for CARE packages.

Throughout history, gold and silver have usually emerged as the preferred mediums. They are easily divisible, difficult to counterfeit and have value in and of themselves. Now Jones can sell his TV for 20 gold coins, spend 5 on eggs, 5 on a hat and save the other 10.

The next part of the organic process is the emergence of warehouses to store money. Carrying your gold everywhere is very inconvenient. So Jones takes the 500 oz. of gold he’s saved up and puts it into a warehouse, paying the owner a storage fee. The warehouse gives him a receipt with which he can claim his money. Now if the business is reputable the receipt can function as money. If Jones wants to buy a cow for 100 oz., he doesn’t have to go back to his warehouse to get the payment; he can just give the receipt for the 100 oz. to Smith who can then either claim the gold himself or use the paper in a future transaction.

That’s all fine and good. To see where things go wrong, say that I open up the Hoste Money Storage Facility (the examples used come from Rothbard’s book but with the names and goods changed). So far I’m storing 1,000 oz. in gold and have receipts out in circulation for exactly that amount. But I then realize something. Almost nobody is ever actually coming in to claim their gold. People are happy passing around my notes. There’s nothing stopping me from printing another 1,000 oz. worth of receipts. I can’t go spend it on mansions and yachts or people may get suspicious. Instead I lend my receipts out and profit off the interest. This is called fractional reserve banking. Rothbard believed that it should be treated as fraud

Now I have 1,000 oz. of gold in my warehouse but receipts in circulation for 2,000 oz. If my receipts are the only things used as money in circulation the price of all goods will double. By printing receipts backed up by nothing for 1,000 oz. of gold I didn’t increase the amount of goods or services in the world. The end result is that there is simply twice as much money chasing the same amount of things. So a poor sap whose life savings totaled 20 oz. of gold has seen the value of it halved (if he has it in Hoste Money Storage Facility receipt form. If he kept in gold, or redeemed his HMSF receipt for the 20 oz. his savings would have the same value).

In addition to being equivalent to counterfeiting and thus stealing, this is a very unstable system. If people start to suspect that Hoste is a fraud and can’t really redeem all his receipts there will be a run on my warehouse/bank. After all my gold is gone, anybody still holding the worthless paper I printed is out of luck.

Why wasn’t fractional reserve banking outlawed from the start? After all, if you put a chair in my warehouse I can’t legally give you one that is different but just as good when you come to claim it. Nor can I print tickets for chairs or televisions which I don’t have. To make a long story short, the money changers have always had better lobbyists than regular warehouse owners.

Enter the Central Bank

The bankers have another problem. In our example thus far there has only been one bank in existence. In the real world there will be many who compete. Imagine Jones is a client at HMSF and trades one of his notes to Smith, a customer at Bayside Banking. The latter will immediately come to HMSF to get his gold. And whenever Jones gets a Bayside note, he’ll do the same. The last thing that bankers want is people to actually redeem the notes that they print. The less customers do that, the better. Banks may agree to take each other’s notes for the convenience of all involved. But say Hoste is printing money faster than anybody else. It may seem to be in my interest to do so, but other banks may start demanding redemption for my notes in gold and I would go under. Although it would be in the interest of all banks to work together expanding at the same rate, there will always be cheaters. But say there was a force that compelled everybody in the industry to synchronize their expansions. As Rothbard explains,

In a free market, as we remember, if a Rothbard Bank expanded notes or deposits by itself, these warehouse receipts would quickly fall into the hands of clients of other banks, and these people or their banks would demand redemption of Rothbard warehouse receipts in gold. And since the whole point of fractional-reserve banking is not to have sufficient money to redeem the receipts, the Rothbard Bank would quickly go under. But if a Central Bank enjoys the monopoly of bank notes, and the commercial banks all pyramid expansion of their demand deposits on top of their “reserves,” or checking accounts at the Central Bank, then all the Bank need do to assure successful cartelization is to expand proportionately throughout the country, so that all competing banks increase their reserves, and can expand together at the same rate. Then, if the Rothbard Bank, for example, prints warehouse receipts far beyond, say triple, its reserves in deposits at the Central Bank, it will not, on net, lose reserves if all the competing banks are expanding their credit at the same rate. In this way, the Central Bank acts as an effective cartelizing agent.

That’s where the banking interest in a Central Bank comes from. How about the state? While bakers, farmers, fishermen, bar owners, barbers, and prostitutes make their living by providing people with goods and services they desire, government only exists by taking from the productive in the form of taxes. But people tend to resist taxation (at least they did until the 20th century). How is the government to raise funds for its parasitic existence?

It has done so by giving itself a monopoly on printing money. When government creates its notes out of thin air the effects aren’t as noticeable as taxation. Unfortunately for the citizen, they’re just as real. This increase in prices that results from government printing money is what’s known as inflation. It makes a fool out of anybody who saves their earnings.

The malign impact of the fed isn’t felt equally throughout society. When government prints money, the people and firms it buys from get the cash before prices rise. After all, it takes time for the money to circulate and the inflationary effects to be felt. The next to benefit are the next people to get the new money, and so on, all to the detriment to the rest of the world. In contrast, under a gold standard a dollar is worth say, 1/100th an ounce of gold (the exact amount doesn’t matter and would be decided by supply and demand: both of paper bills and gold itself. Even an arbitrary price of gold could serve as the basis for a gold standard, although that would be a less purely laissez-faire system). The exact amount isn’t important so long as no one is allowed to legally counterfeit. With hard currency the supply of money is stable (the gold presently being mined is small compared to the stock of the metal in existence) and as long as business efficiency increases the cost of living actually decreases. We are so used to rising prices (a dollar is worth less today than it was 50 or even 5 years ago) that this seems hard to believe. But there is nothing inevitable about inflation.

Rothbard spends a lot of time talking about how the Central Bank came to be. Populist politicians long and hard struggled against it. Debates about central banking were central to American politics for most of the Republic’s history.

Throughout the first century of the Republic, the party favoring a Central Bank, first the Hamiltonian High Federalists, then the Whigs and then the Republicans, was the party of Big Central Government, of a large public debt, of high protective tariffs, of large-scale public works, and of subsidies to large businesses in that early version of “partnership between government and industry.’ Protective tariffs were to subsidize domestic manufactures, while paper money, fractional reserve banking, and Central Banking were all advocated by the nationalists as part of a comprehensive policy of inflation and cheap credit in order to benefit favored businesses. These favorites were firms and industries that were part of the financial elite, centered from the beginning through the Civil War in Philadelphia and New York, with New York assuming first place after the end of that war.

Ranged against this powerful group of nationalists was an equally powerful movement dedicated to laissez-faire, free markets, free trade, ultra-minimal and decentralized government, and, in the monetary sphere, a hard-money system based squarely on gold and silver, with banks shorn of all special privileges and hopefully confined to 100-percent specie banking. These hard-money libertarians made up the heart and soul of the Jeffersonian Democratic-Republican and then the Jacksonian Democratic party, and their potential constituents permeated every occupation except those of banker and the banker’s favored elite clientele.

By the first few decades of the 20th century, however, both parties were firmly in the hands of the bankers. The Federal Reserve Act was passed in 1913. The Senator who pushed hardest for the bill was the son-in-law of John D. Rockefeller. The Bank’s board was stacked with Morgan and Rockefeller cronies.

The US was the last country in the world to adopt centralized banking. Unfortunately, the Bank came just in time to get the country into WWI. If the government could only raise funds for the war by taxation the US would likely have never gotten involved. In addition, some American bankers loaned money to England and France and had an interest in their eventual victory.

As soon as war broke out in Europe, Henry P. Davison sailed to England, and was quickly able to use long-standing close Morgan ties with England to get the House of Morgan named as sole purchasing agent in the United States, for the duration of the war, for war material for Britain and France. Furthermore, the Morgans also became the sole underwriter for all the British and French bonds to be floated in the U.S. to pay for the immense imports of arms and other goods from the United States. J. P. Morgan and Company now had an enormous stake in the victory of Britain and France, and the Morgans played a major and perhaps decisive role in maneuvering thesupposedly “neutral” United States into the war on the British side.

The rush to join WWII was more of the same. FDR would shift the the balance of power from New York to Washington and take the country off the gold standard.

The other major monetary change accomplished by the New Deal, of course, and done under cover of a depression “emergency” in the fractional reserve banking system, was to go off the gold standard. After 1933, Federal Reserve Notes and deposits were no longer redeemable in gold coins to Americans; and after 1971, the dollar was no longer redeemable in gold bullion to foreign governments and central banks. The gold of Americans was confiscated and exchanged for Federal Reserve Notes, which became legal tender; and Americans were stuck in a regime of fiat paper issued by the government and the Federal Reserve.

Over the years, all early restraints on Fed activities or its issuing of credit have been lifted; indeed, since 1980, the Federal Reserve has enjoyed the absolute power to do literally anything it wants: to buy not only U.S. government securities but any asset whatever, and to buy as many assets and to inflate credit as much as it pleases. There are no restraints left on the Federal Reserve. The Fed is the master of all it surveys.

The Money Interests

Rothbard warns us against being uncomfortable taking positions that are outside the mainstream. To believe that the Fed is unjust, all we need is to use our common sense and understand that bankers and state officials are just as self-interested and corrupt as your average citizen.

The Fed has no budget (the great Ron Paul is trying to change that). Nobody in Congress oversees what it does. Even the CIA and Military Intelligence report to elected officials. It’s officials aren’t chosen by the people-the Head is appointed by the President and the Chairs of the regional Federal Banks (the first ones to receive new money) are selected by bankers. Leaders in finance jump into cozy government jobs and vice versa.

Nothing will change until the ruling class is exposed as the gang of thieves that it is. Murray Rothbard was a true crusader for justice and liberty. In our current era we can thank Dr. Ron Paul for bringing this issue to national attention. Intelligent and honorable men are too few.