Thursday, April 7, 2016

More On What Backs the Money


Yesterday we decided that the U.S. Constitution does not give Congress sole power to create money . . . or to create money at all, for that matter.  It does, however, have the power to exchange one form of money for another and (in common with all powers of government) can — and must — delegate that power as it will.  In the Constitution, this is the power to “coin money.”

David Rittenhouse, First U.S. Mintmaster
The easiest and most efficient way for the government to “coin money” (whether coin or notes) within the meaning of the Constitution is to purchase, or borrow the money to purchase, financial instruments in one form, that is, other money, to be able to convert it to the form of currency.  Financial instruments fall into two broad categories: 1) mortgages, and 2) bills of exchange.
A mortgage is a security backed by existing goods or services.  A bill of exchange is a security backed by the “creditworthiness” of the issuer, which is based on the issuer’s ability to redeem the bill at a future date on the occurrence of a specified event.  The basic difference between the two is that the issuer of a mortgage must own what backs the mortgage at the time of issue as it represents existing marketable goods or services, while the issuer of a bill of exchange must have the wherewithal to redeem the bill at the time of redemption, not necessarily when it is issued.
Governments emit a special kind of bill of exchange: the bill of credit.  A bill of credit is defined in constitutional law as “A bill or promissory note issued by the government of a state or nation, upon its faith and credit, designed to circulate in the community as money, and redeemable at a future day.”  As we discussed previously, Congress does not have the right under the Constitution to emit bills of credit.
This is because money is created when one party accepts the offer of another party of a mortgage or bill of exchange.  If offered and accepted in the ordinary course of business, the instruments are called “merchants” or “trade” acceptances.  If offered to and accepted by a mercantile or commercial bank, the instruments are called “bankers” acceptances.
If the acceptance is a mortgage, the original issuer must own the goods or services represented by the mortgage, and at the stated value, at the time of issue, or he has committed fraud by issuing what was once called a “fictitious bill.”  If the acceptance is a bill of exchange, the original issuer must have a reasonable and quantifiable expectation that he will have the full value of the bill on hand to redeem the bill when it matures and is presented.
Federal Reserve
Commercial banks have the power to create money by accepting mortgages and bills of exchange and issuing promissory notes.  The Federal Reserve System was established to convert qualified mortgages and bills of exchange accepted by member banks (a form of large denomination money) into the reserve currency (a form of small denomination money), Federal Reserve Notes, or the equivalent in commercial bank demand deposits at the Federal Reserve.  Bills of exchange were to be presented for rediscount at the discount window of the regional Federal Reserve Bank, while other securities (mortgages and bills of exchange issued by businesses and non-member banks) would be purchased on the open market to ensure adequate liquidity in the system.
Purchases of primary or secondary government securities were not included in the powers originally delegated to the Federal Reserve, with one exception.  In order to retire the debt backed inelastic reserve currency consisting of National Bank Notes, United States Notes, and the Treasury Notes of 1890, and replace them with an elastic, asset-backed currency (Federal Reserve Notes), the Federal Reserve was empowered to purchase government bonds held by the commercial banks (secondary issues) to back their note issues, and gradually replace the government debt backing with private sector asset backing.  This program terminated in 1938.
$1 U.S. Note with picture of Chase (who wanted to be president)
This, however, was still not money creation, for the government debt — bills of credit — was already money, i.e., previously accepted securities.  The Federal Reserve does not have the power, delegated or otherwise, under the Constitution to create money by accepting primary issuances directly from the government and using them to back note issues or demand deposits, any more than the government can constitutionally issue currency and spend it into circulation directly — although that is, in fact, what Salmon P. Chase did when he invented the United States Notes (Greenbacks) to finance the Civil War, and spent the gold he obtained on loan from the commercial banks instead of holding it as agreed to redeem the note issues.
This is why the Treasury and the Federal Reserve maintain the fiction that the Federal Reserve deals only in secondary government securities on the open market: The Federal Reserve is strictly prohibited from dealing in primary government securities in any market, but can — through a loophole — deal in secondary issues, thereby technically not creating money because the brokers who accepted the primary issuances from the Treasury in the first place are doing that, holding them for a microsecond, and then offering the “existing money” created by their acceptance on the presumably “open market” having turned them into secondary issuances by their initial acceptance.
How Congress currently creates money
The bottom line is that Congress is currently “creating money” only by sleight-of-hand through exploiting a loophole that should have been plugged nearly eighty years ago, and is acting unconstitutionally in doing so.  Money can only legitimately be created by anyone when there are either already existing assets to be monetized, or when assets will be put in place by the creation of the money itself; there must always be assets owned by the issuer — not liabilities — to back all money that is created.
Note also that under the Capital Homesteading proposal, all new money created by the Federal Reserve will be done in ways that create new owners of productive assets, although there will be no discrimination; every child, woman, and man will receive the equal right to participate in money creation to finance new capital formation and thus become an owner of productive assets on equal terms with everyone else, regardless whether one has nothing, or a fortune that dwarfs that of Bill Gates.
#30#

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