Page 3 of
5 THE ROAD TO
HYPERINFLATION, Part 2 A failure of central
banking By Henry C K Liu
decades has centralized wealth. Central
banking carries with it an institutional bias
against economic nationalism or regionalism as
well as a structural bias in favor of economic
centralism. It obstructs the delivery of wealth
created at the periphery back to the periphery.
After 1837, the US federal government had
no further connection with the banking industry
until the National Bank Act of 1863. Although the
Independent Treasury that operated between 1846
and 1921, which had to pay out its own funds in
specie money
and be
completely independent of the banking and
financial system of the nation, did restrict
reckless speculative expansion of credit, it also
created a new set of economic problems.
In
periods of prosperity, revenue surpluses
accumulated in the Treasury, reducing hard-money
circulation, tightening credit, and restraining
even legitimate expansion of trade and production.
In periods of depression and panic, on the other
hand, when banks suspended specie payments and
hard money was hoarded, the government's
insistence on being paid in specie tended to
aggravate economic difficulties by limiting the
amount of specie available for private credit. The
Panic of 1907 exposed the inability of the
Independent Treasury to stabilize the money market
and led to the passage of the Federal Reserve Act
in 1913, which allowed the Federal Reserve Bank, a
private corporation, to coin money and regulate
the value of the common currency.
Taking money from the people The
1863 US National Bank Act amended and expanded the
provisions of the Currency Act of the previous
year. Any group of five or more persons with no
criminal record was allowed to set up a bank,
subject to certain minimum capital requirements.
As these banks were authorized by the federal
government, not the states, they are known as
national banks, not to be confused with a national
bank in the Hamiltonian sense. To secure the
privilege of note issue they had to buy government
bonds and deposit them with the comptroller of the
currency.
When the Civil War began in
1861, newly installed President Abraham Lincoln,
finding the Independent Treasury empty and
payments in gold having to be suspended, appealed
to the state-chartered private banks for loans to
pay for supplies needed to mobilize and equip the
Union Army. At that time, there were 1,600 private
banks chartered by 29 different states, and
altogether they were issuing 7,000 different kinds
of banknotes.
Lincoln immediately induced
the Congress to authorize the issuing of
government notes (called greenbacks) promising to
pay "on demand" the amount shown on the face of
the note, not backed by gold or silver. These
notes were issued by the US government as
promissory notes authorized under the borrowing
power specified by the constitution. The total
cost of the war came to $3 billion. The government
raised the tariff, imposed a variety of excise
duties, and imposed the first income tax in US
history, but only managed to collect a total of
$660 million during the four years of Civil War.
Between February 1862 and March 1863, $450 million
of paper money was issued. The rest of the cost
was handled through war bonds, which were
successfully issued through Jay Cooke, an
investment banker in Philadelphia, at great
private profit. The greenbacks were supposed to be
gradually turned in for payment of taxes, to allow
the government to pay off these greenback notes in
an orderly way without interest. Still, during the
gloomiest period of the war when Union victory was
in serious doubt, the greenback dollar had a
market price of only 39 cents in gold.
Undoubtedly these greenback notes helped
Lincoln save the Union. Lincoln wrote: "We finally
accomplished it and gave to the people of this
Republic the greatest blessing they ever had -
their own paper to pay their own debts." The
importance of the lesson was never taught to Third
World governments by neo-liberal monetarists.
In 1863, Congress passed the National Bank
Act. While its immediate purpose was to stimulate
the sale of war bonds, it served also to create a
stable paper currency. Banks capitalized above a
certain minimum could qualify for federal charter
if they contributed at least one-third of their
capital to the purchase of war bonds. In return,
the federal government would give these banks
national banknotes to the value of 90% of the face
value of their bond holdings. This measure was
profitable to the banks, since with the same
initial capital they could buy war bonds and
collect interest from the government and at the
same time put the national banknotes in
circulation and collect interest from borrowers.
As long as government credit was sound, national
banknotes could not depreciate in value, since the
quantity of banknotes in circulation was limited
by war-bond purchases. And since war bonds served
as backing for the notes, the effect was to
establish a stable currency.
The system
did not work perfectly. The currency it provided
was not sufficiently elastic for the needs of an
expanding economy. As the government redeemed war
bonds, the quantity of notes in circulation
decreased, causing deflation and severe hardship
for debtors. Money seemed to be concentrated in
the Northeast, while Western and Southern farmers
continued to suffer chronic scarcity of cash and
credit, not unlike current conditions faced by
Third World debtor economies.
After the
Civil War, the Independent Treasury continued in
modified form, as each administration tried to
cope with its weaknesses in various ways. Treasury
secretary Leslie M Shaw (1902-07) made many
innovations; he attempted to use Treasury funds to
expand and contract the money supply according to
the nation's credit needs. The panic of 1907,
however, finally revealed the inability of the
system to stabilize the money market; agitation
for a more effective banking system led to the
passage of the Federal Reserve Act in 1913.
Government funds were gradually transferred from
sub-treasury "vaults" to district Federal Reserve
Banks, and an act of Congress in 1920 mandated the
closing of the last sub-treasuries in the
following year, thus bringing the Independent
Treasury System to an end.
Populism and
monetary politics John P Altgeld, a German
immigrant populist who became the Democratic
governor of Illinois in 1890, attacked big
corporations and promoted the interest of farmers
and workers, to give the state an able, courageous
and progressive administration. The question of
currency was central to the US populist movement.
Farmers knew from first-hand experience that the
fall in farm prices was caused by the policy of
deflation adopted by the federal government after
the Civil War and only ineffectively checked by
the Bland-Allison Act of 1878, coining silver at a
fixed ratio of 16:1 with gold, and the Sherman
Silver Purchase Act of 1890. The Treasury's
redemption of silver with gold increased the value
of money and deflated prices.
Despite the
rapid growth of business, the government
engineered a sharp fall in the per capita quantity
of money in circulation. The National Bank Act of
1863 also limited banks' notes to the amount of
government bonds held by banks. The Treasury paid
down 60% of the national debt and reduced
considerably the monetary base, not unlike the
bond-buyback program of the Treasury in 1999. To
farmers, it was unfair to have borrowed when wheat
sold for $1 per bushel and to have to repay the
same debt amount with wheat selling for 63 cents a
bushel, when the fall in price was engineered by
the lenders. To them, the gold standard was a
global conspiracy, with willing participation by
the US Northeastern bankers - the money trusts who
were agents of international finance, mostly
British-controlled.
President Grover
Cleveland, despite winning the 1892 election with
populist support within the Democratic Party, gave
no support to populist programs. Cleveland saw his
main responsibilities as maintaining the solvency
of the federal government and protecting the gold
standard. Declining business confidence caused
gold to drain from the Treasury at an alarming
rate. The Treasury then bought gold at high prices
from the Morgan and Belmont banking houses at
great profit to them. Populists saw this effort to
save the gold standard as a direct transfer of
wealth from the people to the bankers and as the
government's capitulation to international finance
capital. Cleveland even sent federal troops to
Illinois to break the railroad strike of 1894,
over the vigorous protest of governor Altgeld.
The election of 1896 was about the gold
standard. Cleveland lost control of the Democratic
Party, which nominated 36-year-old William Jenning
Bryan, who declared in one of the most famous
speeches in US history (though mostly shunned
these days): "You shall not press down upon the
brow of labor this crown of thorns, you shall not
crucify mankind upon a cross of gold." The banking
and industrial interests raised $16 million for
William McKinley to defeat Bryan, who suffered a
defeat worse than Jimmy Carter's by Ronald Reagan.
With the McKinley victory, the Hamiltonian ideal
was firmly ordained, but with most of its
nationalist elements sanitized and replaced with a
new finance internationalism. It was not
dissimilar to the Reagan victory over Carter in
1980 in many respects.
The 16th amendment
to the US constitution calling for a "small"
income tax was enacted to compensate for the
anticipated loss of revenue from the lowering of
tariffs from 37% to 27% as authorized by the
Underwood Tariff of 1913, the same year the
Federal Reserve System was established. "Small"
now translates into an average of 50% with federal
and state income taxes combined. Free trade is
only free in the sense that it is funded by the
income tax.
The supply-side argument that
corporate tax cuts stimulate economic growth only
holds if at least half of the benefits of the tax
cut are channeled toward rising wages instead of
higher return on capital with the additional
benefit of lower capital gain tax. Thus a case can
be made to couple all corporate tax cuts with an
index on wage rises to match or exceed corporate
earnings. One of the reasons why strong corporate
earnings have not helped the current credit crisis
can be traced to the disproportional rise in
equity prices having come from stagnant wages in
the same corporations.
The Glass-Owen
Federal Reserve Act was passed in December 1913
under the administration of President Woodrow
Wilson. The system set up five decades earlier by
the National Bank Act of 1863 had two major
faults: 1) the supply of money had no relation to
the needs of the economy, since the money in
circulation was limited by the amount of
government bonds held by banks; and 2)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
