Yesterday we claimed that the Federal Reserve is not acting unconstitutionally, regardless whether it is a branch of the government or a private corporation. Whether or not the federal government has the power to create money instead of simply setting the standard and regulating the value, the power to create money is not exclusive, as some people believe. The word "exclusive" is nowhere mentioned in connection with money in the Constitution.
Striking coins is specifically prohibited to the individual states, but a literal reading of Constitution is that the individual citizens retain the right to issue coins and currency, whether or not this means "creating money." In fact, in the early decades of the United States, there were a significant number of privately issued coins in circulation, some of them even accepted by the federal government in payment of taxes and customs duties. Ask any U.S. numismatist about the Bechtlers of South Carolina, for example, or Moffat and Company of California.
Today's topic is not whether the State has exclusive power to create money, however, but the role of the central bank. What is generally considered the world's first central bank, the Bank of England, was established in 1694 primarily to deal in bills of exchange as an accommodation to merchants and other banks. It became the chief financing vehicle for the English (later British) government as the result of a forced loan as a condition for receiving its charter.
As the Bank of England extended its activities (apart from government business), it helped establish a uniform and more or less stable currency throughout England. That is, a pound note issued by a "country bank" that had privileges at the Bank of England was worth the same as a Bank of England pound note. Further, as long as it was convertible into gold or silver coin or bullion, the paper currency would pass at par with the metallic currency.
The main purpose of a central bank, however, is to turn privately issued money — bills of exchange — into "current money" or currency by discounting and rediscounting. Neither a central bank nor a commercial bank can actually create money. All they do is transform one form of money into another, and charge a fee for the service.
In this way an economy always has an adequate supply of liquidity for industry, agriculture, and commerce. Discounting and rediscounting "real bills" (i.e., commercial paper backed by the present value of existing hard assets and future marketable goods and services) is the application of Say's Law of Markets, and a way of ensuring that supply equals demand, and demand equals supply, without having to worry about cutting consumption to accumulate cash.
If you think that the Federal Reserve is being used improperly, and are more interested in correcting things than in pursuing and punishing those who are guilty, guilty, guilty, consider attending the annual rally outside the Federal Reserve building in Washington, DC, this Friday, April 15, 2011. It starts on the front sidewalk of the White House (1600 Pennsylvania Avenue) at 10:15 am, then we-all walk to the Federal Reserve at 11:00 and regroup at the Federal Reserve at noon, and go to 1:30 pm.
Be there, or be . . . something.