Thursday, February 14, 2013

Avoiding Monetary Meltdown, I: Andrew Jackson’s War on the Economy


Consider this an “open letter” to Virginia Delegate Bob Marshall.  Following up on yesterday’s posting regarding Virginia Delegate Bob Marshall’s proposal to study the possibility of instituting a specie (i.e., gold and silver) currency to fend off the potential of hyperinflation due to mushrooming government debt.  Also (if we understand the proposal) the idea is to eliminate the possibility of computer terrorism destroying the financial system by making a commodity (gold), not electronic media, the only money supply.

We believe the proposal displays a limited understanding of money, credit, banking and finance.  Bob really ought to talk to CESJ president Norman Kurland, who can work with Bob to develop a specific proposal to achieve the same ends without the disastrous consequences that would attend such a deflationary program.

You might want to send Bob an e-mail at delegatebobmarshall [at] Hotmail [dot] com to that effect after reading today’s posting — if you haven’t done it already.  We sent him one, which we’ve broken up into a series for easy handling.  Today we look at how Andrew Jackson almost destroyed the U.S. economy by mandating that the federal government only accept gold and silver coin as money:

February 12, 2013

Dear Mr. Marshall:

Norman Kurland forwarded me your e-mail, “Helping Wall Street or Main Street?”  I fully support your goal of a stable and asset-backed currency, and an end to the extremely risky, not to say dangerous policies currently being pursued by the Federal Reserve.

That being said, however, I have to repeat what I said in my previous e-mail, that as a Certified Public Accountant and a citizen of the Commonwealth of Virginia I have grave reservations concerning the viability of the proposal itself, its theoretical basis, and the inevitable effect that limiting the money supply exclusively to specie would have on the economy.

The United States has never in its history had a money supply composed exclusively, or even predominantly of gold and silver.  The only attempt ever made — in the 1830s by means of Andrew Jackson’s 1836 Specie Circular (which he left to be enforced by Martin Van Buren) — limited the effort solely to the public sector at a time when the public sector was very small.

The Specie Circular ordered the federal government, at that time representing a miniscule fraction of the total U.S. economy, to refuse to accept anything other than gold or silver in payment of taxes and for land purchases.  Land sales were at that time the single largest source of revenue for the federal government.

There was, however, so little gold and silver in the economy (and most of it in foreign coin, legal tender until 1857) that the transactions demand just to pay taxes and purchase federal land drained the gold and silver reserves of the commercial banks.  The country was instantly plunged into a depression, “Hard Times.”

It is important to realize that the gold and silver held by private banks did not back the banknotes — small denomination promissory notes — issued by the banks, or the demand deposits they created.  The gold and silver was for reserves, i.e., legal tender currency kept on hand to satisfy the demand for convertibility of the banks’ promissory notes into “lawful money.”  This gave the public confidence in the banks’ note issues.

When the increased demand from the federal government for gold and silver under the Specie Circular drained the banks’ reserves of precious metal, the banks were forced to suspend convertibility.  The public lost confidence in the banks’ note issues, and trade and commerce ground to a halt.

The situation becomes understandable when we realize that there was simply not enough gold and silver in the economy to meet the transactions demand for money, even by the federal government.  This was at a time when Alexis de Tocqueville noted in Democracy in America (1835, 1840) that the federal government was so unimportant that it could hardly be said to govern at all.  This is the case whether we are looking at money in the relatively limited form of coin or banknotes, or in the predominant form of bills of exchange.

Virginia Congressman George Tucker estimated in his book The Theory of Money and Banks Investigated (1839) that merchants’ and bankers’ acceptances — bills of exchange — made up 95-99% of the U.S. money supply during the 1830s.  Writing in 1916, Dr. Harold G. Moulton, later president of the Brookings Institution (1928-1952) noted that private sector asset-backed bills of exchange made up 75-80% of the U.S. money supply in the early twentieth century.  By 2008, a rough calculation suggests that such bills of exchange accounted for approximately 60% of the money supply, with government bills of credit accounting for the balance.

The fact is that gold and silver coin (including gold and silver certificates representing coin or bullion on deposit in the U.S. Treasury) has only ever been supplementary to banknotes and demand deposits as the currency for daily consumer transactions.  This is true whether we are looking at government debt (bills of credit) or private sector hard assets (bills of exchange) as backing for the banknotes.  Even banknotes have been a very small portion of the overall money supply.  The vast bulk of the money supply has always consisted of bills of exchange and mortgages that circulate as money among businesses and banks.

Consequently, in the 1830s the public lost confidence in bills of exchange and promissory notes issued by businesses and banks, respectively, as the specie reserves were depleted to meet the increased transactions demand of the federal government in the form of specie.  As productive activity slowed as a result of inability to obtain credit, even cities and states were forced into bankruptcy as the tax base disappeared.

This caused later historians to claim that states and municipalities had overextended their credit to build infrastructure, thereby causing Hard Times.  No — the taxes and user fees needed to make good on the bonds could not be collected due to the drastic decline in the economy that had already occurred.

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