Tuesday, April 30, 2013

Why a Central Bank?, III: What Do We Do?

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Immediately after the presidential campaign of 1912, Woodrow Wilson began hedging on his promise to do something about the financial system.  This, of course, was unacceptable to William Jennings Bryan, who had been made Secretary of State in return for his critical support in getting Wilson elected.

Bryan began pushing hard, and the legislation for the new Federal Reserve System went through.  Contrary to popular legend, there was nothing secret about the Federal Reserve Act.  It was one of the longest and hardest fought legislative battles in the history of the United States.

From our perspective, the Federal Reserve System solved three out of four important problems, at least on paper, and only temporarily:

• The inelastic National Bank Note and Treasury Notes of 1890 currencies were to be replaced with elastic Federal Reserve Note Currencies.

• The government debt backing of the National Bank Notes and Treasury Notes of 1890 was to be replaced with private sector asset backing.

• The Federal Reserve Note currencies (there were twelve of them, one for each region) were to pass at par and be convertible into all the other currencies in circulation, e.g., gold and silver coin and certificates, and with each other.

The one problem the establishment of the Federal Reserve did not solve was democratic access to money creation by ordinary citizens.

This became a moot point, because to finance entry into the First World War the Congress decided to take advantage of a loophole in the Federal Reserve Act.  Since one of the main purposes of the Federal Reserve was to replace the currency backed by government debt with currency backed by private sector hard assets, it had to be able to purchase government debt on the open market to replace the National Bank Notes with Federal Reserve Bank Notes.

Instead of using this power to retire debt, however, the Federal Reserve was persuaded by Congress to use it to increase debt by buying Liberty and Victory bonds.  Technically, of course, these were not actually bonds used to borrow existing savings, but bills of credit emitted as money.

After the war the Federal Reserve began retiring the debt, but the 1929 Stock Market Crash and the Great Depression ushered in the Keynesian New Deal — financed with massive increases in government debt.  World War II was also financed on debt . . . ironically in direct contravention of Keynes’s own recommendation!

Consequently, the Federal Reserve virtually ceased discount operations except for politically motivated bailouts, and confined its open market operations to dealing in government securities.

Part of the Capital Homesteading proposal is to return the Federal Reserve to its original mission of providing liquidity to the private sector and stop using it to monetize government deficits.  Consistent with binary economics, of course, all new money would be created in ways that make people into capital owners, thereby providing them with a means of acquiring and maintaining a Capital Homestead to match the 1862 land-based Homestead Act.

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