While it may seem counterintuitive, the problem with the currency described in "McCain, Bush and the Dollar" ("Review & Outlook," WSJ, 09/04/08, A18) is readily solvable. It's not a matter of cutting spending, tax breaks, or even manipulating interest or exchange rates. It's a question of whether whoever is elected president has the backbone to restore soundness to the U.S. dollar and the economy at the same time. This seemingly impossible task is relatively simple, although requiring a degree of political and economic fortitude seldom seen in recent decades. It requires a proper use of the Federal Reserve System to finance capital formation in the private sector, and turning off the federal lending spigot.
According to the Congressional report from the subcommittee charged with investigating the causes of the "Panic of 1907," and the Federal Reserve Act of 1913, the Federal Reserve System was established to accomplish four objectives:
• Break the monopoly of money and credit centered in New York City under the control of J. P. Morgan.In order to prevent the federal government from being able to monetize its deficits, the Federal Reserve was (and is) prohibited from dealing in primary government securities. The loophole that allows the Federal Reserve to deal in secondary government securities was to enable the Federal Reserve to regulate reserve requirements of commercial banks, as reserves could only be in the form of cash or government securities.
• Regulate the banking system, in part to democratize access to the clearinghouse system for small commercial and deposit banks, and to oversee reserve requirements of commercial banks.
• Provide a depository for federal funds.
• Most important, the twelve Federal Reserve banks were to function as regional development banks, providing a flexible and asset-backed currency to supplement gold and silver coin and U.S. Treasury certificates representing gold and silver to meet the needs of industry, commerce, and agriculture within a district and prevent both inflation and deflation of the currency.
By financing all new capital formation by means of loans discounted by commercial banks at the Federal Reserve and shutting down open market operations in secondary government securities,
• Asset backing would be restored to the currency.If all new capital formation were done in such a way as to expand the base of capital ownership throughout society, through, e.g., ESOPs that pass through the vote and pay meaningful dividends or through a proposal called Capital Homesteading for Every Citizen (from the book of the same title), purchasing power would be spread throughout the economy, jobs would be created, and the currency appreciate in value — all without the ill effects that necessarily accompany attempting to accomplish these same objectives through Keynesian means.
• There would be no need for foreign investment capital or the existing pools of savings of the wealthy (who could then spend their income as they wished).
• The power of the federal government to increase the deficit at will would be broken.
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