Federal Reserve Follies: What
Really Started the Great Depression
View from the Other Side of the Brink
by Antal E. Fekete
July 27, 2006
The Sorcerer's Apprentice
The basic error underlying the Quantity Theory of Money (QTM) is
the notion that central banks can command their newly created money
to flow to the commodity market, or any other market of their choice.
This is the pipe-dream of the Sorcerer's Apprentice. In reality,
once the newly created money is off the premises it is no longer
under central bank control. It has become a plaything in the hands
of speculators. Far from being guided by the wishful thinking of
central bankers, speculators follow their own agenda. They are motivated
by profit potential as they see it emerge in various markets. It
is true that, on occasion, the commodity market is their preferred
playground and mischief to prices is the result. But it could just
as well be the stock, bond, or real estate market. It is also true
that there is a "trickle-down" effect on the commodity market as
the newly created money is spent again and again by subsequent recipients
who are not speculators. But by the time money trickles down to the
commodity market damage has already been done elsewhere. Whether
peddled under the name "monetarism" or "neoclassical economics",
the QTM is utterly inapplicable to the modern economy and cannot
explain changes in the price level. The linear relationship between
the stock of money and the level of commodity prices that may have
held in more primitive societies up to medieval times has been replaced
by a highly non-linear one modulated by speculation.
Allow me to say here that the QTM is one of those bad ideas that
will probably never go away because of its intuitive appeal. It can
be grasped even by the most primitive intelligence not conversant
with monetary economics. People not inclined to consult the more
profound works of economists who have blasted the QTM to smithereens
again and again as have, for example, J. Laurence Laughlin of Chicago
University, Edwin Kemmerer of Princeton, Walter E.Spahr of New York, not
to mention Adam Smith, want to have something they can understand
even if it will, more often than not, distort the big picture beyond
recognition.
Condoning the violation of the law
This is a rejoinder to the paper of Richard H.Timberlake of the
same title dated August 2005. For the sake of argument I shall adopt
Timberlake's own division of the economic collapse into two distinct
events: the 1929-1933 Great Contraction and the 1933-1941 Great Depression.
They were preceeded by the inflationary monetary regime under the
domineering leadership of Benjamin Strong, Governor of the Federal
Reserve Bank of New York, between 1922 and 1928. Although Timberlake
characterizes it as one animated by a high-minded "stable price level
policy," it was an unlawful regime continuously violating the law.
Strong introduced illegal "open market operations" for the first
time. He established the Open Market Investment Committee of the
New York Federal Reserve Bank in 1922 under his own chairmanship.
It conducted buying and selling, mostly buying, of Treasury bonds
for the account of the Federal Reserve Bank of New York as well as
some other Federal Reserve banks. The bonds purchased in the open
market were paid for in the form of Federal Reserve notes and deposits
created out of nothing for this specific purpose. The advent of open
market operations of central banks has changed the landscape of world
finance beyond recognition. It made official manipulation of bond
and stock prices possible. It turned traditional virtues and vices
upside down: thrift into vice, sharp trade practices into virtue.
The monetization of Treasury debt was illegal according to the Federal
Reserve Act of 1913. It was not authorized. As a matter of fact,
the use of government bonds for the purpose of backing Federal Reserve
notes and deposits was explicitly ruled out. Stiff penalties were
prescribed in case, and to the extent, the liabilities of a Federal
Reserve bank could only be balanced through its portfolio of Treasury
paper. Of course, Strong and his cohorts were aware that they were
breaking the law. They argued that this policy was not official;
that it was designed to meet an emergency; and it would be terminated
as soon as the emergency has passed and the international gold standard
was made operational once more. No doubt, this was one of those 'emergencies'
that was invented to become permanent. Strong himself was instrumental
in preventing the gold standard from becoming operational again by
sterilizing gold that had come to the United States from European
belligerents in payment for war supplies. It would be closer to the
truth to say that central bankers have tasted the elixir of power,
and liked it. They have become addicted to it. Never mind that it
was forbidden fruit for them. They wanted to exhaust the entire cup.
They knew that they could manipulate Congress to legalize retroactively
the power they had illegally grabbed.
The violation of the law as a substitute for changing it whenever
its efficacy is brought into question is a serious matter in any
case. But it is especially serious and pernicious when it affects
the processes whereby money is created. Legal ends cannot justify
illegal means under the law. If an officer of the Federal Reserve
can take liberties with the law, then so can anybody else, and the
bottom line is counterfeiting the currency. Timberlake passes over
the blatant violation of the law in silence, presumably because of
his sympathies with the hidden monetary inflation that he (in unison
with Milton Friedman and Anna Schwartz) admiringly calls "the Fed's
stable price-level policy". Hardly did he notice that what he admired
was not monetary policy under Strong, but a mere coincidence: the
knack of the speculators who for reasons of their own put the newly
created money to work, not in the commodity market where inflation
would have been noticed immediately, but in the real estate and the
stock markets where it could remain hidden for a longer period of
time. In the event the Strong-inflation could not be swept or kept
under the rug for too long. It soon showed up in the shape of the
Florida real estate bubble (1924) and the stock-market orgy (1929).
In addition, it kept interest rates artificially low (and bond prices
artificially high) with the effect that the investment-decisions
of businessmen became distorted. Again, the concomitant misallocation
of economic resources could not be detected immediately. But the
writing was on the wall that the chickens would eventually come home
to roost, as indeed they did during the Great Depression. To sing
a song of praise of the Strong-inflation is not fitting to a monetary
economist.
Condoning the violation of the law and blaming the consequences:
the Great Contraction of 1929-1933 and the Great Depression of 1933-1941
on the Real Bills Doctrine (RBD) is, to say the least, disingenuous.
This is not to suggest that the Federal Reserve Act of 1913 was a
good law. Most likely it was not, and the United States could have
managed, thank you very much, without a central bank in the 20th
century, as it did in the 19th. But this is another issue to be investigated
separately. Here I want to condemn a procedure whereby the law is
violated in order to create a fait accompli,forcing the hands
of lawmakers to change it so that, in the end, the violation be justified,
nay, rewarded. Once the Strong-inflation induced stock-market speculation
was under way, money from abroad was sucked in causing a serious
deflation in Europe and elsewhere. Central bankers from around the
world started making their regular pilgrimages to New York begging
Strong for even more inflation. They had hoped that lower interest
rates in America would bail them out. Strong was delighted to comply
with their pleading. Thus the violation of the law created international
complications and ultimately Congress had to amend the Federal Reserve
Act of 1913 so as to legalize the practice of open market operations
-- euphemism for monetizing the the public debt. The cure for the
ill effects caused by an illegal monetary inflation was to be more
monetary inflation, not less, making sure that this time around it
was fully licensed and legalized.
Today no economist would think of open market operations as being
originally conceived and introduced as an illegal practice, or would
dream of suggesting that the explanation for the Great Contraction
that followed it can be found in the violation of the law. I hereby
take the task upon myself to make this revelation. It has to be stated
in unambiguous terms that the Strong-inflation of 1922-1928 celebrated
by Irving Fisher, Milton Friedman, Anna Schwartz, Richard Timberlake,
and other devotees of the QTM, was illegal. I am of course aware
that the grant departments of the Federal Reserve banks will never
support research to explore this episode more fully to confirm my
accusations. I still hope that incorruptible economists, especially
the younger generation, are motivated by the truth rather than bribe
money, and will rise to my challenge in doing the necessary research.
Exonerating the gold standard is not enough
Following Keynes it has been fashionable to blame "contractionist
tendencies" inherent in the gold standard for the Great Depression.
Timberlake, to his credit, makes a valiant effort to exonerate this
venerable institution. As the German monetary economist Heinrich
Rittershausen said, it was not the gold standard that failed but
the people to whose care it had been entrusted. It is unfortunate
that Timberlake's concept of the gold standard is faulty. He quotes
Joseph Schumpeter approvingly who describes the international gold
standard as an institution linking the price level in one country
with that in all other countries 'on gold'.
But this is not what the gold standard does, nor is it the way it
is supposed to work. The price level is too 'sticky' for adjustment
through gold flows, however attractive the QTM model of price adjustment
may appear. Gold flows were conspicuous only through their absence
during 100 years of international gold standard ending in 1914. Furthermore,
although the gold standard had a mechanism for the equalization of
the discount rate between various countries, this did not mean an
automatic equalization of interest rates. The two rates are conceptually
very different, as are the forces governing them. They could move
in the same or in opposite directions. The adjustment mechanism of
the gold standard operates, not on the price level which is sluggish,
but on the discount rate which is nimble. It is not gold flows but
the flow of real bills, and the flow of underlying merchandise in
the opposite direction, that perform the balancing act, keeping the
economy on an even keel. Here is how. Suppose certain countries suffer
from a natural disaster or experience crop failure, causing widespread
shortages. The discount rate in these countries will rise above that
prevailing abroad, making the stricken countries attractive on which
to draw bills. Consumer goods are dispatched immediately to the high
discount-rate countries from the low. Relief is instantaneous.
It was not a flow of gold but that of real bills on London, maturing into
gold in less than 91 days, that financed world trade prior
to World War I. Gold hardly ever left the vaults of the Bank of
England. Its relatively small gold reserve could finance a world
trade several times as large. Without real bills world trade could
have never expanded the way it did during this Golden Age. By 1913
it reached a record high that could not be surpassed for the next
75 years. Timberlake commiserates that the gold standard was in
'remission' during the years following World War I. It is true
that the garrison states that emerged after the signing of the
peace treaties were pursuing highly protectionist policies. The
efficiency of gold in financing world trade has fallen from the
high level reached during the years prior to World War I. Lip service
was still being paid to gold thereafter, but the garrison states
embraced mercantilistic ideas and they were determined to wean
their subjects from the gold coin. They foolishly concentrated
gold in official coffers rather than putting it to work in reconstruction
and in refinancing world trade. They sterilized gold by letting
their central bankers sit on it. The United States was no exception.
Why should Governor Strong put excess gold reserves into circulation
in the form of gold coins? He knew that the outcome would be losing
his cherished dictatorial powers. Open market operations and gold
coin circulations are incompatible.
Gold inflation is a red herring
Of course, Strong argued that putting gold coins into circulation
would be 'inflationary'. Timberlake agrees. They are wrong. Even
if all the world's monetary gold had descended upon the United States
and were put into circulation, there would have been no price increases.
The (natural) discount rate would go to zero. As a consequence vendors
could do their 'vending' with zero capital (i.e., they could sell
first, and pay for the merchandise out of the proceeds). Marginal
merchandise would be displayed on sidewalks, public squares offering
shoppers a previously unheard-of variety of goods. The abundance
of gold coins would call out an equal abundance of consumer goods.
Circulating capital would expand, matching the increase in gold coin
circulation to finance trade in marginal merchandise. Automatically
and immediately. The maxim that 'more money chasing fewer goods brings
higher prices' does not apply, provided that the color of the money
is yellow and it has the right ring to it when plunked down on the
counter. The collapsing discount rate will see to it that a sufficient
abundance and variety of goods is always available. Prices need not
rise on account of a greater abundance of gold coins in circulation.
'Gold inflation' is a red herring.
Conversely, there would have been no deflation when European countries
recovered after the war and started repatriating their gold. The
contraction of the pool of circulating gold coins would make the
(natural) discount rate rise in the United States. Vendors of marginal
merchandise would fold tent. Circulating capital financing trade
in marginal merchandise would shrink, matching the decrease in goldcoin
circulation. The variety of goods available to consumers would be
reduced accordingly. Prices need not fall on account of a reduced
abundance of gold coins.
Discounting is not lending
It is not enough to exonerate the gold standard which cannot be
fully understood without a proper understanding of the RBD. This
Timberlake clearly does not have. In real bills he sees a 'false
anchor' competing with gold in the balance sheet of the central bank.
In his view the central bank monetizes real bills. The bill is merely
a collateral securing the loan and could be replaced by bonds that
could also be used for the same purpose. In reality they could not.
Banks do not acquire real bills in consequence of a passive manoeuvre
such as securing a loan. Just the opposite is the case: discounting
(rediscounting) real bills is an active bank manoeuvre. The
bank (central bank) takes the initiative and goes out to acquire
an earning asset. The bill is not a collateral security for a bank
loan, neither is the merchandise underlying it. The real bill is
an earning asset that is second to none in liquidity (it is second
to gold but gold is not considered an earning asset). For a commercial
bank, asset liquidity is a primary concern because in a squeeze,
or to meet a run on the bank, these assets may have to be mobilized
and thrown on the market simultaneously and indiscriminately. Even
government bonds cannot come close to real bills as far as their
liquidity is concerned. If mobilized and thrown on the secondary
market in a panic (as it happened after World War I in 1921), bond
prices would collapse and interest rates would shoot up. Yes, even
for government bonds. By contrast, real bills are always in demand
as long as the underlying goods are. One-ninetieth of the portfolio
of bills of every commercial bank matures on every single day of
the year. To maintain revenues the bank has to replace them. If one
bank has to sell, it will always find another that wants to buy.
Even if the taste of consumers has changed, the short maturity of
the bills, 91 days (or 13 weeks, or 3 months, or one quarter) makes
it certain that bills in disfavor will expire and disappear quickly,
long before they could cause mischief. In the worst-scenario case,
the drawer of the bill would pay it at maturity even if he had to
take a loss. He would do it lest he lose his discounting privileges
for good.
The fact that real bills are the most liquid earning asset a bank
can have, combined with the fact that the real bill 'matures' into
gold coins released by the consumer in buying the underlying good,
makes these instruments very special. In the asset pyramid they come
right after the monetary metals. It is wrong to look at real bills
as competition for gold. Real bills are supplementing gold in financing circulating
capital, not competing with it. No prior saving is necessary.
It is sufficient that the underlying merchandise be in urgent demand.
On the other hand, real bills cannot and will not finance fixed
capital. To do that you must have savings in the form of gold.
People who insist that prior savings is also a prerequisite for the
financing of circulating capital are myopic. There is no way society
could save enough to finance the entire circulating capital of a
modern economy, in addition to financing its fixed capital. A simple
back-of-the-envelope calculation can convince any open-minded observer
of that. Real bills, and only them, can make it possible that gold
is not tied up unnecessarily in moving merchandise in urgent demand
to the consumer expeditiously. Gold, thus released, can then be used
to form new fixed capital in financing more roundabout processes
of production. The great improvements in the productivity of capital
in the 19th century would not have been possible without this division
of labor between gold and real bills.
When a bank discounts a real bill, it is not making a loan
(even though pro forma the transaction may be dressed up as
such). Rather, the bank acquires a self-liquidating paper
which at maturity is paid out of the proceeds of the sale of merchandise
described on the face of the bill. The gold coin released by the
ultimate consumer liquidates the bill. Other loans that the bank
may make are not self-liquidating. In more details, at maturity the
borrower has to invade the pool of circulating gold coins and withdraw
the necessary amount. Should too many loans of this type wait in
line to be liquidated simultaneously, there would be a problem. Unless
banks could make snap loans to credit-worthy customers, there would
develop a squeeze on the money supply. Innocent third parties would
find it difficult or impossible to discharge their obligations. Defaults
could cascade. This is the stuff out of which depressions are made.
This was the core problem after the stock-market collapse in 1929
which revealed that businessmen had been misled by artificially low
interest rates. There were no profitable investments on the horizon.
There were no credit-worthy borrowers to take the loans the banks
were so desperate to make. As a result, the stock of money collapsed
as a pricked balloon, replicating the collapse of the stock market.
The case is different with self-liquidating loans. As long as people
want to be fed, clad, and sheltered in warm homes in winter, there
will always be an adequate supply of real bills, and banks may compete
for them. Nobody is squeezed and there is no threat of cascading
defaults. As I have said it is wrong to assume that the banks take
the real bill, or its underlying merchandise, as a collateral for
loan. It is wrong to say that the bank monetizes real bills. It is
the market that in fact does the monetization. Discounting
bills is not a lending funcion of the bank, but a clearing function.
This was known to Adam Smith already well over two centuries ago.
He said that real bills could circulate on their own wings and under
their own steam. What the banker does is this: he goes out and buys
them as the most eligible prime earning asset he can have, one that
can always be liquidated in an emergency without fear of a loss,
regardless of the vagaries of the interest rate and the economy.
The gold standard and the RBD in the Federal
Reserve Act of 1913
Timberlake states that the idea of a central bank was anathema to
the newly elected Democratic Congress and president in 1912. The
presumption was that a central bank is monolithic and monopolistic.
It would not serve the public. Rather, it would further the interest
of the bankers. We may be well-advised to take this view of Woodrow
Wilson and his Congress with a grain of salt. True, they may not
have suffered the expanded power of the banking establishment gladly
as it existed then. But this did not mean that they would
not embrace unlimited power to monetize government debt, given the
opportunity to do so. In particular, Secretary of State William Jennings
Bryan was a dyed-in-the-wool inflationist. There is a painting on
display in the Treasury Building on Pennsylvania Avenue depicting
him as he gleefully signs the very first Federal Reserve notes ready
to be rushed into circulation on Christmas Eve, 1913. This Santa
Claus of the century has given the world the Federal Reserve, the
income tax, no-sweat financing of wars (declared or undeclared),
in one word: unlimited power concentrated in the Washington establishment,
epitomized by the unlimited power to monetize public debt. This power
was grabbed unconstitutionally through the unlawful introduction
of open market operations less than ten years later. Even before
that, the Federal Reserve was a tool in the hands of trigger-happy
politicians who faced a country with no stomach for getting entangled
in a fratricidal war on another continent an ocean apart. The warmongers
were determined to get a piece of the action by hook or crook. For
starters they were eager to finance the trade in war material, especially
as it was being dispatched to the Entente powers in violation of
the Neutrality Act. Needless to say, financing foreign wars fought
by foreigners on foreign soil for foreign interests was not the purpose
for which the Federal Reserve System had been established. But let
us not make a shortcut in relating events as they unfolded.
It is true that Congressmen who sponsored and passed the Federal
ReserveAct of 1913 sincerely believed that the commercial banks'
and the Federal Reserve banks' faithful adherence to the RBD would
make the monetary system self-regulating, so that the involvement
of the Federal Reserve as a central bank could be kept at a bare
minimum. Five years of diligent research, after the panic or 1907,
had gone into the preparation of the legislation. As mentioned by
Timberlake, prominent economists such as H. Parker Willis and Adolph
C. Miller, both former students of J.Laurence Laughlin of the University
of Chicago, played a crucial role in this research. Not mentioned
by him was Paul Warburg, an immigrant from Germany with connections
to banking circles there, who brought with him the experience and
expertise of the Reichsbank, established a few dacades earlier, after
a careful study of banking principles with characteristic German
thoroughness. The law governing the operation of the Reichsbank was
animated by the RBD. Most of its provisions were also written into
the Federal Reserve Act of 1913. Carter Glass was the Chairman of
the House Banking and Currency Committee nursing the Bill that was
to become the Federal Reserve Act. As Timberlake observes, Laughlin
was a long-time opponent of the QTM. Miller, together with Willis,
supported his criticism of this simplistic theory. In Congress, Carter
Glass promoted the pro-RBD and anti-QTM ideas into law.
Hijacking of the Federal Reserve by warmongers
The Federal Reserve Act of 1913 was not a perfect document. In many
ways it was rather imperfect. It did not close loopholes whereby
real bills could be made to do overtime and consequently become stale
in the portfolio of Federal Reserve banks, that would be a drag on
the system. The distinction between real bills and accommodation
or anticipation bills was not made watertight. Above all, the very
idea that the country's gold must be entrusted to 'reserve' banks,
rather than to the people themselves by putting it into circulation,
is a monstrosity. Be that as it may, the Act had the attributes of
a reasonable legislation to prevent inflationary and deflationary
adventures of an activist central bank. The idea of linking the emergence
of new currency to the emergence of goods and services in urgent
demand (and the retirement of currency at the time of the sale of
merchandise or completion of service) was sound. Resisting the temptation
to organize the public debt into currency was admirable. Under a
more favorable constellation of the stars the experiment of founding
a central bank of the people, for the people, by the people, may
have succeeded.
Unfortunately, constellation was anything but propitious. The fledgling
institution had no chance to succeed in its mission. The Guns of
August shot the gold standard, and the bill trading supplementing
it, to pieces. Enemies of private enterprise, free trade, and the
ideal that the individual knows best what is good for him, together
with collectivists of all spots and stripes, saw a great opportunity
coming their way presented by the fratricidal war overseas. The socialist
minorities sitting in European parliaments, without exception, voted
all the war credits governments asked for and then some, in effect
throwing out the gold standard as useless baggage inappropriate to
carry along in wartime. In reality, the retention of the gold standard
would have greatly shortened the war. As taxes to pay for the prolongation
of war had had to be increased, the pressure on belligerent governments
to make peace would have intensified.
At least in Europe where nationalistic fervor could reach fever
pitch the blind sentiment to continue the war to total victory or
death was understandable. But in the United States the European war
did not make sense to ordinary people. Their ancestors came to this
continent to escape the arbitrary war-making power of kings. No pet
wars for presidents here, they had thought. The country stayed neutral
for the first three years of the conflict, in spite of ongoing political
intrigues to take the plunge. The Constitution had assigned the power
to declare war to the House of Representatives, and congressmen would
not antagonize their pacifist constituents by war-mongering. It was
in the president's official family where warmongers found a niche
and could prepare the ground for the United States' entry to the
conflagration, through provocation if need be.
We shall never know what would have happened if two momentous events:
the eruption of war in Europe, and the Federal Reserve banks' opening
their doors for business, had not coincided in the fateful year of
1914. One thing is certain: the world would be quite different from
what it is now.
The Great Contraction
Strong died while in office in October, 1928. The removal of this
tyrant gave a chance to his enemies to crawl out of the woodwork.
They did not delay making the system conform to RBD guidelines as
required by the Federal Reserve Act -- a most unfortunate development
in the view of Timberlake. Here is another interesting historical
coincidence. Two events: the bursting of the stock market bubble
fed by the Strong-inflation, and the death of Strong were separated
by just one year. We shall never know what would have happened if
Strong had lived to continue his open market operations in the 1930's.
Timberlake says that the Great Contraction would have been avoided.
Strong would have pumped even more money into the system, anticipating
Greenspan's response to the "irrational exuberance" of the stock
market. We may agree, for the sake of argument, that this could have
postponed the crisis. Yet it is certain that the crisis caused by
a growing amount of central bank money in circulation could not be
put off forever. Timberlake's assumption is tantamount to assuming
that damage caused by inflation can be cured by more inflation ad
infinitum. However, in our more sober moments we should admit
that inflation cannot survive as a permanent monetary policy. The
Fed combats falling prices by open market purchases of bonds, and
it combats rising interest rates -- you have guessed it -- by more
open market purchases of bonds. The cure is always the monetization
of more government debt, regardless whether you are combatting inflation
or deflation. Just print more money, rain or shine. We know from
history how inflationary adventures inevitably end. There could be
nuances of difference, but deflation that follows inflation as night
follows day cannot be avoided, no matter how much government debt
is monetized by the central bank.
The Federal Reserve Board minus Strong had the unenviable task to
rein in the unbridled Federal Reserve credit that was feeding the
stock market orgy. They tried to do this as gingerly as they could.
Credit contraction is always painful. The pain that goes with contracting
an unprecedented credit expansion is no less unprecedented. Timberlake
is right in assuming that the Great Contraction has run its course
by 1932 and there were signs of recovery in early 1933. Why did then
the Great Depression follow so hard on the heels of the Great Contraction?
Here the use the RBD as whipping boy that can be conveniently blamed
for deflation comes handy. Timberlake does not pretend that his thesis
is original. Indeed, it is not. You could have become a Nobel prize
laurate in economics for suggesting it first. But even a dozen Nobel
prizes cannot overtake truth.
Why the Great Depression?
Although the Great Contraction in the wake of the Strong-inflation
was unavoidable, the Great Depression was not. The world was sucked
into it not because of the RBD but in spite of it.
If Timberlake does not see it that way, it is due to his faulty understanding
of the RBD, which is inseparable from the gold standard. Real bills must mature
into gold coins. Otherwise the RBD makes no sense. Why can't a real
bill mature in Federal Reserve notes? If it could, it would not have
come into existence in the first place. An omniscient and omnipotent
Fed could helicopter-drop just the right amount of Federal Reserve
notes, when needed, where needed, for the smooth functioning of the
economy. They tried that approach in Bolshevist Russia, with results
only too well-known. The experiment was discontinued in Russia's
'Evil Empire' in 1990. Now they try it again in the U.S. and its
very own Evil Empire. As Benjamin Franklin has said, experience runs
an expensive school, but fools will learn in no other.
Just as the world economy was making its first tentative steps to
recovery in 1933, the international gold standard -- and together
with it the bill market -- were mortally wounded by saboteurs. The
newly elected Democratic President, no less strong a man than Governor
Strong, took the law, and the Constitution, into his hands in March,
just a few days after inauguration. Under the threat of heavy fines
and prison terms he called in all gold coins and gold certificates
by issuing a Presidential Proclamation. Next, he cried down the value
of the Federal Reserve notes in terms of gold, the very same notes
that had been paid out 'in compensation' to holders of gold. In other
words, the president used the strong arm of government to pauperize
the citizenry. Pity poor Henry VIII. He was being mocked as "Old
Coppernose". Yet the vilest thing he ever did to the coin of the
realm was to give it a gold wash. When the wash rubbed off after
a few years of wear and tear, the copper nose on his effigy became
plainly visible. Ownership of solid gold coins was not made illegal.
People who could see through the cheap trick were not harmed. Those
who were, could at least have a good laugh for their money whenever
they looked at the coin counterfeited by their sovereign. But what
this president did amounted to raping an entire nation. People were
deprived of their gold coin they needed to validate their demand
for consumer goods. Thereafter producers of goods and services would
not take orders directly from the consumer bereft of his gold coin.
Instead, they would take orders from the issuers of purchasing media,
the bankers. They were the ones to call the shots, and to pay the
piper. The consumer must take it or leave it.
Timberlake does not see this. He insists that the 'gnomes' of the
Federal Reserve have smuggled real bills back into circulation for
doctrinaire reasons. Their plot could not possibly work. Production
has stopped (or nearly so) and the flow of real bills dried up, making
the economy come to a screeching halt for lack of purchasing media.
Meanwhile gold was piling up in the vaults of the Federal Reserve
Bank of New York well in excess of reserve requirements, doing nothing.
Surely, a strong leader such as Strong would have issued Federal
Reserve credit against this gold, and the Great Contraction as well
as the Great Depression would have been avoided, according to Timberlake.
This betrays his incomplete understanding of the RBD, which makes
the availability of gold coins to the consumer an absolute prerequisite.
Here is what would have happened, had the dictatorial-minded president
not confiscated gold. The RBD would have been allowed to operate.
As foreign gold flowed to the country, it would be monetized, and
the discount rate would be driven lower, perhaps all the way to zero.
The United States would have become the clearing house for real bills
originating from all over the world. The movement of goods in international
trade would have been financed by real bills drawn on New York, just
as prior to World War I world trade had been financed by real bills
drawn on London. The low discount rate would have revived the export
industry of the United States. Recovery of production for the domestic
market could have proceeded apace. The apalling unemployment would
have never happened. The Great Depression would have been avoided.
None of this was going to occur because the boat of the international
gold standard has been torpedoed and real bills, being tied to the
mother ship, went down with it.
Lionizing saboteurs
Timberlake is blaming the victim of a disaster for the disaster
caused by sabotage. The RBD could have been the savior had it not
perished along with the gold standard at the hand of collectivist
assassins. Real bills could have revitalized world trade and revived
the world economy. But the lion's share of world gold had been sequestered
and made unavailable for any purpose whatever by a megalomaniac.
Bereft of its gold, the world had no choice but go through the meat-grinder. It
was no coincidence that the beginning of the Great Depression coincided
with the incarceration of gold.
Timberlake should refrain from lionizing lesser saboteurs such as
Strong. It appears that his hero is the Latter-Day Strong alias Alan
Greenspan. Unfortunately, he says, Greenspan may have come too late
and may have left too early. The task of enforcing the "stable price-level
norms of Benjamin Strong" has remained unfinished. I quote: "The
huge unfunded liabilities of the federal government, as they come
due in coming decades, are going to require the U.S. Treasury to
pay them. The Treasury will have to 'get the money' to do so. It
will 'ask' the Fed for 'help' in keeping interest rates 'down'. Whereupon
the Fed, unless it has a Chairman made of titanium steel, will buy
those Treasury securities in the open market -- yes, holding interest
rates 'down' temporarily, but thereby creating new money and initiating
an ongoing central bank inflation. The German model [of hyperinflation]
of 1923 will be only too applicable."
Is this not exactly what Governor Strong, not having a constitution
'made of titanium steel', had done and would have continued doing
had he not succumbed to tuberculosis in 1928? Can the policy of curing
the ill effects of inflation with more inflation have any other ending?
Abstract
"Federal Reserve policies were one hundred percent responsible for
the Great Contraction and the subsequent Great Depression. The damage
done both materially and ideologically was, and is, inestimable.
Ignorant govermental reactions to the debacle resulted in vast expansions
of incursions in the economy, and in a vast expansion of powers that
no Supreme Court could stop. Worse still, the common misconception
of a market system that had 'failed', resulted in a popular ethos of
anti free-market regulation and governmental interventions that have
increased exponentially with no end, or even equilibrium, in sight."
My agreement with this assessment of Timberlake is complete. Our
difference is centered on the question whether the follies of the
Federal Reserve consisted of its abiding by the law, or violating
it. This article makes the case that violation of the law, regardless
whether you consider it good or bad, creates far greater problems
than those it may hope to solve. It also points out that gold coin
circulation is a sine qua non of the RBD. Timberlake ignores
the implications of the fact that the newly inaugurated president
confiscated the gold coins of the people on March 4, 1933. The coincidence
of that day, which will 'live in infamy', with the beginning of the
Great Depression was no coincidence.
References:
Richard H.Timberlake, Federal Reserve Follies: What Really Started
the Great Depression, http://mises.org/blog/archives/timberlake.pdf,
August, 2005
Milton Friedman and Anna Schwartz, A Monetary History of the United
States, 1867-1960, Princeton U.P., 1963
Bill Koures, Real Bills: an Emergent Market Phenomenon, http://www.safehaven.com/showarticle.cfm?id=3846,
September 26, 2005
Nelson Hultberg, Real Bills vs. Rothbard's 100 percent Gold System, http://www.afr.org/Hultberg/090605.html,
September 6, 2005
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Antal E. Fekete is Professor Emeritus at Memorial University
in St. Johns, Newfoundland. Born and educated in Hungary, he emigrated
to Canada after the Hungarian Revolution in 1956 and taught for 35
years in the field of mathematics. Over the years, he has been a
visiting professor or Fellow at Columbia University, Princeton University,
and Trinity College of Dublin. He worked in the Washington office
of Congressman W.E. Dannemeyer on monetary and fiscal reform for
five years in the nineties; and in 1996, he won first prize in the
prestigious International Currency Essay contest sponsored by Bank
Lips Ltd. of Switzerland. He is the author of Gold and Interest and Monetary
Economics 101. In addition, his scholarly articles have appeared
on numerous Internet sites such as Financial Sense Online, Free-Market
News, Gold-Eagle, SafeHaven, and LeMetropoleCafe.
E-mail: aefekete@hotmail.com
