Yesterday we looked at how Hjalmar Schacht, the “Old Wizard”
with the unlikely middle name of “Horace Greeley” (no, really — he was born in
New York City while his parents briefly lived there), stabilized the German
currency in the 1920s, putting an end to the hyperinflation that followed World
War I. Of course, on the downside, this
laid the foundation of the German resurgence that in less than a decade took
the country from absolute zero to nearly conquering the world, but that’s a
different issue. The point to keep in
mind is that it is possible to turn even a complete economic basket case
completely around in less than a decade.
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| Charles A. Conant, "hard money" advocate. |
Greece does not have to demonetize its national currency,
however, or shift to another currency (although that could be beneficial if
done properly) because the Euro currency union is — for the time being — not
the immediate problem. It’s a serious
problem, of course, but not one that must
be dealt with right now. It should be,
of course, but it doesn’t have to be — and that’s all a politician needs to
hear to do nothing.
What Greece needs to do, however, is shift from debt backing
for its Euros and private sector money supply (mortgages and bills of exchange), to asset backing — and it can be done, because it has been done,
and without causing massive disruption in the economy. Like Greece needs any more disruption. . . .
We can take as our model the program adopted by the United
States in 1913 with the passage of the Federal Reserve Act — as it was
originally designed, not as it is being (mis)used today. To understand that, though, we need a little history as background.
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| Salmon P. Chase, the man who would be president. |
Briefly, during the Civil War Abraham Lincoln’s Secretary of
the Treasury, Salmon P. Chase, decided to finance the Union war effort using debt
instead of raising taxes. Charles A. Conant, a leading "banking principle" authority,
hinted that Chase wanted to be president, and thus didn’t want to be identified
with raising taxes. That is also, by the way, why Chase had his picture put on the first issue of $1 United States Notes: he wanted people familiar with his face so they'd vote for him (Congress forced him to change the design). Chase got away with debt financing, though, because Lincoln seems not to
have given a damn where the money came from as long as it came. Saving the Union and, later, freeing the
slaves was more important than bad monetary and fiscal policy.
Consequently, “hard” money — gold, silver, and even copper
nickel coinage — disappeared from circulation, replaced with private tokens and
postage stamps for small change, and inflated greenbacks (United States Notes
backed by government debt) for larger transactions. By the end of the war, one dollar in gold was
worth a minimum of $2.64 in paper, and the credit rating of the federal
government had fallen drastically in the European markets.
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| A $1 National Bank Note (issued only until 1878) |
Unfortunately, the at-first-official and, later, unofficial
policy of deflation following the war to restore parity of the gold and paper
currencies (i.e., making a paper dollar and the gold dollar pass at par, meaning having the same value) resulted in a lowering of prices and a shrinking pool of past
savings for farmers and small businessmen.
At the same time, the rich industrialists and commercial interests could obtain
all the money they wanted or needed by issuing bills of exchange based on
future savings and either using them directly (merchants or trade acceptances)
or discounting them at the new National Banks that also served as commercial
banks.
Ironically, the National Bank Notes intended to replace the
debt-backed United States Notes were also debt-backed. Their only advantage was that the amount that
could be issued was strictly regulated. Interestingly, the $1 and $2 National Bank Notes were only issued until 1878, when $1 Silver Certificates and Treasury Notes of 1890, and $1 and $2 United States Notes replaced them.
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| William Jennings Bryan: "No cross of gold!" |
Making matters worse was the falling price of silver
relative to gold. Because of falling
prices for wheat and other agricultural products, farmers had to produce (for
example) two bushels of wheat to pay back a loan that only bought one bushel of
wheat. As a result, the Populists led by
William Jennings Bryan, “the Great Commoner,” began demanding “free silver.”
“Free silver” did not mean that everybody could get silver
for free. It meant that as much silver
as people brought to the mint would be coined and pass into the economy as
money. It also meant inflation because
the amount of silver in a silver dollar (or any other coin struck in silver) was worth much less
than a dollar due to massive production and the falling price of silver. Inflation would mean that farmers and small
businessmen could get out of debt much easier by repaying with cheap silver
instead of expensive gold — recall how France was able to leverage the fall in the price of silver to reduce the real value of the indemnity it paid to Prussia in the early 1870s.
The government refused to allow free silver, but did
purchase a lot of silver to try and get the price up. The government issued bonds, the bonds were
used to back the Treasury Notes of 1890, The Treasury Notes of 1890 were used
to purchase the silver, the silver was coined into silver dollars, the silver
dollars were deposited in the U.S. Treasury, and the U.S. Treasury issued
silver certificates to circulate instead of the silver dollars. Thus, for every silver dollar in the
Treasury, there was more than $1 in circulation. The inflation did not, however, offset the falling price level, because the falling price level was due more to increased productivity of the new capital instruments than to deflation of the Greenback currency.
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| A $100 "Yellow Back" Gold Certificate, Series 1882. |
The United States thus had three separate debt-backed paper
currencies all circulating at the same time, the United States Notes
(“Greenbacks”), the National Bank Notes, and the Treasury Notes of 1890. In addition, there were Silver Certificates
(backed with silver dollars with less than $1 in silver in each one) and Gold Certificates ("Yellow Backs"), as well as the bronze, copper-nickel, and silver token (effectively
debt-backed) currency, and the full-value gold currency.
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| A $20 Treasury Note of 1890 |
This meant that the U.S. federal government had seven official
currencies, three of which were 100% debt-backed, two that were partially
debt-backed, and two that were asset-backed.
The U.S. private sector, however, had two unofficial “currencies”:
mortgages and bills of exchange, both of which were asset-backed. The money supply in the United States
therefore consisted of nine different kinds of money — but only the rich could
get asset-backed money when they needed it by issuing bills of exchange. Everybody else had to make do with a fixed
amount of currency that never seemed sufficient to meet the needs of ordinary
people.
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| "Double Eagle" of 1894: $20 gold ("baggy", i.e., scratches). |
The problem seemed insoluble. To have a stable money supply the reserve
currency (the debt-backed National Bank Notes) had to be convertible into an
asset on demand. This meant the quantity
of National Bank Notes had to be strictly regulated to avoid inflation, and the
government had to avoid going into too much debt, or there wouldn’t be enough gold
to meet the demand for convertibility of the reserve currency.
At the same time, because people believed the currency had to be backed by debt, the government
simply had to have some debt
outstanding . . . which was manageable as long as the politicians didn’t start
cranking up the printing presses to cover deficits or to be able to spend to
meet political goals . . . the same problem Greece faces today.
On Monday we’ll look at how the United States solved this
dilemma . . . even if it didn’t stick to it for more than a couple of years. .
. .