Maybe
it was the tagline that caught our attention: “Suddenly banks everywhere are
in deep, deep trouble.” (“The Return of
Crisis,” Peak Prosperity Blog, February 8, 2016.) After we finished laughing, we decided that
the reason for our merriment might make a good blog posting. It still does, even though it was from
something we saw on the internet a couple of weeks ago.
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| Sealing the Bank of England Charter, 1694 |
It
was the “suddenly” that got us. There
has been nothing “sudden” about the trouble banks are in. It’s been building up since the establishment
of the Bank of England as the world’s first true central bank in 1694.
The
Bank of England was established to ensure that England’s mercantile banks
(their term for “commercial banks”) always had “accommodation,” that is, could
always get credit and always had sufficient reserves. A central bank was only ever intended to be a
“bank for banks.”
So
how did central banks get into financing government? In order to ensure that the Bank of England
always had enough gold and silver reserves to lend to its member mercantile
banks, all the member banks deposited £1.2 million in gold and silver, then applied
for a charter so the Bank could legally operate as a corporation.
 |
| William III: "Yew may hev yo chawtaw for £1.2 million." |
King
William, however, needed cash.
Revolutions, no matter how Glorious, are expensive, and that £1.2
million in specie (gold and silver) was very tempting. So the king and parliament cut a deal with
the Bank of England: “loan” the government £1.2 million worth of gold and
silver, and the government will pledge £1.2 million in “government stock”
(interest bearing debt) as security for the loan. In return, the Bank would get a 48-year
charter.
In
this way the Bank became the government’s banker instead of the banker for
banks. Government debt paper became as
good as gold (and silver) because it had the government’s word behind it. The whole faith and credit of the British
government stood behind the debt paper that now served as reserves instead of
gold and silver.
Of
course, if something happened to the government, or the private sector couldn’t
produce enough to support the tax base that supported government debt, then
government debt paper was not quite as good as gold. Thus, every time there was a political
upheaval, or the possibility of a political upheaval, or people thought there
might be the possibility of something happening, the public rushed to convert
their banknotes backed with government debt into gold.
This,
of course, caused gold reserves to plummet, convertibility would be suspended,
and the paper money would depreciate in terms of gold, and the price level
would rise. The answer the economists
came up with was to end convertibility into gold permanently, and back the
entire money supply with government debt.
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| Knapp: The State Theory of Money |
This
is called “chartalism,” and was developed by Georg Friedrich Knapp in the 1880s
as a way of shifting from capitalism to socialism without an armed revolt. John Maynard Keynes adopted chartalism as the
basis of his monetary theories, with the result that today economists and
politicians have a hard time imagining that anything other than government debt
can back a currency.
So
what’s wrong with backing the money supply (or even just the currency) with
government debt? Doesn’t the government
have the sole right as a sovereign entity to create money, and nobody else has
it?
Well
. . . no. The government doesn’t
actually have the right to create money, not even the United States
government. If we read Article I, § 8 of
the Constitution carefully, we see that a certain key phrase is omitted from
the enumerated powers: “emit bills of credit.”
A “bill of credit” is the special constitutional term meaning “create
money.”
Now,
that doesn’t mean that a government cannot restrict the manufacture of coin or
other forms of currency to itself, or create a standard for the currency. That’s different from creating money, and is
a proper job for government.
In
fact, government creation of money backed only by its own debt is (as most
authorities agree) what started the modern business cycle of “boom and
bust.” This was the cause of the “Panic
of 1825.”
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| "Vive l'ME! |
Following
the Napoleonic Wars and the breakup of the Spanish Empire, the governments of
the new republics of Central and South America were a trifle short of
cash. Consequently they financed
operations by floating massive quantities of debt, much of it of rather dubious
quality. Some was so dubious that the country
issuing it didn’t even exist . . . .
By
1825, government debt had become the single largest type of security traded on
the world’s exchanges. When the
governments of Central and South America started defaulting on their debt, a
financial panic ensued. This dried up
credit for private sector productive use, and the global economy went from boom
to bust.
When
the private sector managed to get back into shape, governments (as usual) began
spending more than they collected in taxes, creating more money backed by their
own debt, and throwing a monkey wrench into the economy by increasing demand
beyond current productive capacity. This
spurred a “boom” which collapsed when the government couldn’t make good on its
promises or private sector producers couldn’t increase production fast enough
to keep up with government spending, and the cycle started all over again.
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| J.M. Keynes: "Don't worry. Just print and spend money." |
Keynesian
economics and its “counter-cyclical” approach didn’t solve this problem. All it did was cover it up with a lot of
spackle in the form of flooding the channels of commerce with more government
debt. Had productive capacity not
managed to keep pace, largely by means of tremendous technological advances,
the crash would have come decades ago.
It’s
coming closer and closer now because, for all the productive potential of the
world’s economies, fewer and fewer people are able to be productive. If people can’t be productive, they can’t
purchase what others produce: production equals income, per Say’s Law of
Markets. The fewer people who are
producing and are thus able to sustain demand naturally without inflation or
redistribution, the worse the ultimate crisis is going to be.
“The
Return of Crisis”? It never left. The problem is what to do about it —
something we’ll address on Monday.
#30#