Myths of the Money Machine

So many wars to fight, so much welfare to dish out. Life is difficult for those who rule us. How are they going to pay for it all and still command our respect? Trying to remake the world with taxes alone won't do it ' there's always the chance, however slim, that Americans would protest. Politicians thus need a way of getting more money without actually taking it from us. Impossible as it may sound, they've developed a near-perfect scheme for doing just that: our central bank, the Federal Reserve System. Since 1913, the Fed has played a key role in expropriating wealth to fund an expansive welfare state and an endless stream of foreign entanglements. The Federal Reserve was up and running by late 1914, and by 1917 was cranking out money to provide most of the funding for American entry into World War I, 'the war to end all wars,' currently in its 'Iraqi Freedom' phase. Of course, war and its attendant loss of life, liberty, and wealth are only a few of the many blessings the Fed makes possible. The Fed exists to inflate the money supply, that is, to increase the amount of money in circulation. Imagine what you could do if you could legally print your own money and force others to accept it. The government has. That's why it created the Fed. Most of us have to produce something and sell it before we get money to spend. Not so with the Fed--with the touch of a key, it creates whatever money it needs and goes shopping, just like your garden-variety counterfeiter. What it normally buys are government bonds to support deficit spending. This handy little scheme enables government to grab wealth like an army of cat burglars. Inflation thus amounts to a virtually transparent wealth-transfer scheme. It enhances the power of politicians to buy votes at home and pick fights overseas. The Fed's apologists, meanwhile, keep telling befuddled citizens that their central bank is like a pacemaker, a mysterious device keeping them alive. By 1929, only 15 years after it had been in operation, the Fed had been a principal source of revenue for the world's most destructive war and had fueled an investment mania that brought on the Depression. Was the Fed's existence questioned or given second thought? Definitely in some quarters, but not by those controlling the levers of power. Politicians are not going to abolish a money machine. Better to let the dollar go to ruin and replace it with something equally inflatable. Nowhere is government intervention more insidious than in our monetary system. And nowhere has economic mythmaking achieved greater success than in shoring up the Federal Reserve. Let's review some of these myths: Myth #1: Government directly or through its central bank needs to control the money. If money were left to the free market, the results would be catastrophic. In the beginning there was no money. People sustained their lives or not in hand-to-mouth fashion. Then they started bartering. Certain items became more popular than others in the barter process and were exchanged not for their own sake but to acquire other goods. These more marketable items served as media of exchange, or money. As Murray Rothbard tells us, 'Through the centuries, two commodities, gold and silver, have emerged as money in the free competition of the market, and have displaced the other commodities.' [1] Money, therefore, originates on the market as a commodity in high demand for its own properties. It then becomes demanded as a medium of exchange as well. Unlike legitimate enterprises that acquire money through production and exchange, government gets its revenue through expropriation. But even with the anesthetizing effects of withholding, taxation alone is a risky proposition for politicians. That's why they debauch the currency. But before they can do that, they have to control it. It takes a long time for government to develop the inflationary muscle it has today. When real money was circulating, government had to declare a monopoly of the minting process so it could practice coin debasement ' mixing other metals with gold or silver to increase the money stock. To get away with debasement, it needed legal tender laws to force acceptance of its cheapened coins at face value. [2] But coin debasement as a principal means of inflation requires effort and takes time. This was inflation's Dark Ages, but light was emerging. People began depositing their coins with goldsmiths for safekeeping and convenience, receiving claim tickets in return. The tickets came to be trusted as much as gold and circulated as money substitutes. Seeing a way to exploit this trust, some goldsmiths started issuing receipts not backed by gold. In other words, they practiced counterfeiting. Time passed, and banks took up counterfeiting under the euphemism 'fractional reserve banking.' They kept gold in their bank vaults which represented only a fraction of the bills they issued, hoping that not everyone would demand gold conversion at the same time. The circulation of counterfeit deposit receipts inflated the money supply. Counterfeiting, then, is another name for inflation. Rather than declaring fractional reserve banking a form of fraud and making it illegal, politicians working closely with big bankers decided to use government power to enshrine it. They borrowed ideas from the Europeans, and in 1910 devised a central bank at a hunting retreat on Jekyll Island, Georgia. Three years later, a close version of their scheme became the Federal Reserve Act. [3] As long as paper dollars were redeemable in gold, the Fed was limited in the amount of counterfeiting it could get away with. The Fed-caused crisis of the Depression provided the conditions needed to eliminate this barrier. After Roosevelt confiscated the people's gold in 1933, the dollar was redeemable in gold only to foreign governments and central banks. When Nixon repudiated U.S. gold obligations internationally in 1971, gold disappeared entirely as a check on inflation. For the first time in American history, the dollar was a pure fiat bill, totally without backing. Thus, money begins as a highly valued commodity facilitating exchange on a free market, then government, using its monopoly on coercion, seizes control of the monetary system so it can inflate at its pleasure. Fed chairman Alan Greenspan has more to say about this in myth #6 below. Myth #2: The Federal Reserve exists to serve and protect the general public. The Fed is a government-backed banking cartel in charge of the country's money supply. A cartel exists to ensure profits among its members and to bar competitors from its market. It needs government guns to make it work, and both the cartel and government need massive propaganda to sell the idea to the public. The banking cartel, of course, is really a front for the government. By forcing us to accept its money, government serves its interests at our expense. We sometimes hear that the Fed protects us from monetary crises. As the creator of money that enables banks to make cheap loans, the Fed specializes in booms that go bust and over its history has managed to depreciate our dollars into nickels. Far from being our protector, the Fed engages in practices guaranteed to result in crises. Myth #3: As a central bank, the Fed is one of the hallmarks of a modern free economy. At the Fed, a handful of people decide how much money will exist at any given time, then impose their decisions on the rest of us. Central banking is a form of central planning. It is at odds with and destructive of a free economy. Like central planning generally, central banking is fundamentally flawed: The authorities have no way of knowing to what degree its credit expansion is hurting the economy. For instance, in the '20s, the Fed inflated, prosperity was high, and prices were stable. Everyone was getting rich, until late October, 1929. Could the Fed do any better today? During a speech at Jackson Hole, Wyoming in 2002, Fed Chairman Alan Greenspan told the audience oncoming trains were difficult to see. 'We at the Federal Reserve considered a number of issues related to asset bubbles--that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact--that is, when its bursting confirmed its existence.' [4] And even if the Fed could see it coming, he added, there was not much they could do to stop it. A free economy restricts government to the protection of property rights, if it tolerates government at all. As a wealth-transfer catalyst, the Fed is a violator of property rights. As a central bank serving special interests, the Fed is one of the hallmarks of a corrupt society. Myth #4: The Fed promotes our prosperity. Capital investment derived from savings raises productivity and thereby promotes prosperity. When the Fed creates money out of nothing, like a child playing make-believe, it erodes the value of the dollar and thus reduces the amount of savings available for capital investment. The Fed's cheap money induces massive borrowing, moving scarce resources into risky ventures. Market signals of profit and loss are greatly distorted, though the frenzy of activity seems like good times. Financial reckoning day eventually arrives, no matter how clever the Fed is in delaying it. Money is the price of wealth, not wealth as such. Wealth is the goods and services money can buy. Increasing the supply of lumber increases our prosperity. Increasing the supply of money raises its price. Myth #5: Inflation per se is not necessarily bad. Low to moderate inflation actually stimulates the economy. In 1997, Javier Andr's and Ignacio Hernando co-authored a paper titled 'Does Inflation Harm Economic Growth?' [5] Among their conclusions were the following (from a summary of their paper): Andr's and Hernando find that even low or moderate inflation rates . . . have a temporary negative impact on growth rates, leading to significant and permanent reductions in per capita income. A reduction in inflation of even a single percentage point leads to an increase in per capita income of 0.5 percent to 2 percent. As the authors point out, their analysis leaves little room for interpretation. Inflation is not neutral, and in no case does it favor rapid economic growth. Higher inflation never leads to higher levels of income in the medium and long run, which is the time period they analyze. [6] As Bill Bonner and Addison Wiggin note in Financial Reckoning Day, even at three percent inflation, the dollar loses half its value in just 14 years. [7] Is loss of buying power one of the hallmarks of economic growth? In the 1920s, the Fed was inflating and good times rolled. And yet, '[t]he 1920s are not often seen as an inflationary period,' write Rep. Ron Paul and Lewis Lehrman in The Case for Gold, 'because prices did not rise.' [8] As the authors show, the money supply increased from $45.3 billion to $71.1 billion from 1921 ' 1928. So why didn't prices go up? 'The 1920s saw such a burst of American technological advancement and cheaper ways of producing things that the natural tendency was for prices to fall . . . .' Monetary inflation, then, while it was brewing conditions leading to a stock market crash, cheated Americans out of lower goods prices. The new money drove the Dow from 66 in late 1921 to 300 by mid-1929. Thus, prices did rise in the form of stock and real estate bubbles, both of which collapsed. [9] The Fed's Benjamin Strong inflated our money stock during the '20s to help support Britain's welfare state. Only with Strong's death in 1928 did this policy stop. [10] Myth #6: Whatever its faults, the Fed is better than anything else yet devised. Here's what Chairman Greenspan had to say in December, 2002: Although the gold standard could hardly be portrayed as having produced a period of price tranquility, it was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But, in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after that, prices quintupled. Monetary policy, unleashed from the constraint of domestic gold convertibility, had allowed a persistent overissuance of money. As recently as a decade ago, central bankers, having witnessed more than a half-century of chronic inflation, appeared to confirm that a fiat currency was inherently subject to excess. [11] Saying that central bankers 'witnessed' inflation is like saying Nazis witnessed mass executions. At any rate, by 1979, it was 'painfully evident' something had to be done to slow the rate of inflation. Since inflation is an increase in the money stock, the only thing the Fed could do was stop inflating. It did, and the economy fell into a recession from which it recovered. This only proves, said Mr. Greenspan, that 'a prudent monetary policy maintained over a protracted period can contain the forces of inflation.' In other words, this only proves that when the Fed stops inflating, inflation stops. Did the Fed learn a crucial lesson? No. It began inflating again. So why don't we abolish central banking and fiat currency and establish a genuine gold standard, free of government control? Chairman Greenspan offers an explanation, which he wrote in 1966: [G]overnment deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which ' through a complex series of steps ' the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold . . . . In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold . . . . The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. 'Deficit spending,' Mr. Greenspan concludes, 'is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process.' [12] Imagine that. FDR didn't abolish gold because it was a failed medium of exchange; he got rid of it because it interfered with the Fed's ability to fund ever-growing federal deficits. Chairman Greenspan has never repudiated his now-famous 1966 article. In February 2001, he told Rep. Paul: 'I have recently read the article again, and I would not change a word." [13] The heart of our monetary system is a counterfeiting scheme rigged to favor government and the politically connected. Left unchecked, it will ruin our currency, and perhaps worse. Is this the best monetary system yet devised? Of course not. 'Gold stands in the way of this insidious process.' 1. Rothbard, Murray, What Has Government Done to Our Money?, Ludwig von Mises Institute, Auburn, AL, 1990. Pp. 18-19. 2. Sennholz, Hans, Age of Inflation, Western Islands, Boston, MA, 1979. p. 24. 3. Rothbard, Murray, The Case Against the Fed, Ludwig von Mises Institute, Auburn, AL, 1994. Pp. 116, 117. See also: Griffin, G. Edward, The Creature from Jekyll Island: A Second Look at the Federal Reserve, American Media, Westlake Village, CA, 2002. 4. 'Economic Volatility,' Remarks by Chairman Alan Greenspan, August 30, 2002, Jackson Hole, WY

5. 'Does Inflation Harm Economic Growth? Evidence for the OECD,' Javier Andr's & Ignacio Hernando, National Bureau of Economic Research

6. 'Does Inflation Harm Economic Growth?' Summary of Andr's & Hernando's working paper

7. Bonner, William with Addison Wiggin, Financial Reckoning Day: Surviving the Soft Depression of the 21st Century, John Wiley & Sons, Inc., Hoboken, NJ, 2003. p. 139 8. Paul, Ron Rep. And Lehrman, Lewis, The Case for Gold, Cato Institute, Washington, D.C., 1983. p. 123 9. Skousen, Mark, 'Friedman vs. The Austrians, Part II: Was There an Inflationary Boom in the 1920s?' 10. Paul and Lehrman, p. 125 11. Remarks by Chairman Alan Greenspan, Before the Economic Club of New York, New York City, December 19, 2002

12. Greenspan, Alan, 'Gold and Economic Freedom' 13. Taylor, J., 'The Fish Rots from the Head Down,'

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George F. Smith is the author of The Flight of The Barbarous Relic, a novel about a renegade Fed chairman.  Visit his website.