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Thursday, September 23, 2010

Say's Law of Markets, Part XIII: "The Crime of '73"

Ironically, in the same year as the publication of Lombard Street, the United States passed the Coinage Act of 1873. Twenty years later, when the "Panic of 1893" and the following Great Depression exposed the weaknesses in both the American financial system and the understanding of money and credit prevalent in all quarters of the country, the Act achieved a mythical status all out of proportion to its actual effect and importance. In a frenzy of misdirected populist feeling, the Coinage Act was labeled "The Crime of '73," evidently having managed to hide its true nature for almost a generation.

Formation of a Myth

The Act was not the sinister conspiracy that populist legend has built into a financial bogeyman. It was an attempt to repair the damage done to the credit of the United States by the policies of Salmon P. Chase, who was by this time Chief Justice of the United States Supreme Court, although he had only a short time left to live. Chase's actions, as we have seen, had a devastating effect on the purchasing power and financial position of ordinary wage workers. The real problem was that the presumed remedy ignored the true nature of money found in Say's Law of Markets and the real bills doctrine. Both the framers of the Act and its critics were locked, seemingly irrevocably, into the tenets of the Currency School.

By 1896 and the presidential campaign of William Jennings Bryan, the Coinage Act of 1873 had become enshrined in populist dogma as the key event in an international conspiracy intended to force the nations of the world onto a monetary standard of scarce gold instead of plentiful silver. (Walter T. K. Nugent, The Money Question During Reconstruction. New York: W. W. Norton and Company, Inc., 1967, 16.) It was, in the words of Mrs. Sarah E. V. Emery, one of the "seven conspiracies that shook the world" (Sarah E. V. Emery, Seven Financial Conspiracies Which Have Enslaved the American People. Lansing, Michigan: Robert Smith and Co., 1894.) — all coincidentally perpetrated by Congress during the Civil War and Reconstruction. (Nugent, op. cit., 20.)

The "Crime of '73" thereby made harmful deflation instead of beneficial inflation of the currency global policy. The perfidy was made complete by the fact that the predominant currency wasn't even gold, but (in a fiendishly clever move by the National Banks that refused to lend farmers and small businessmen the banknotes without collateral and unless they paid interest) greenbacks ostensibly backed by gold. Thus, the banks benefited twice: 1) by drawing interest on the government bonds that backed the National Bank Notes, and 2) then drawing interest again on the banknotes themselves when paid out to the public in the form of loans. (Ibid., 17)

Take special note of the accusation that the National Banks were making double profits off of the currency, for it was to dominate discussion of money, credit, and banking for the next twenty years. This obscured the serious problems involved with having a fixed currency of gold, silver, and banknotes, instead of a money supply composed of all forms of money (e.g., demand deposits, commercial paper, drafts, letters of credit, and so on) that could expand and contract to meet the needs of industry, commerce, and agriculture.

The Case for Inflation

Although it dominated politics from 1893 to 1913, the accusation that the National Banks were making double profits on the currency was false. This is because the vast amount of loans for industrial, commercial, and agricultural purposes were not made in the form of National Bank Notes, but as demand deposits — checking accounts — that were not backed by government bonds, interest-bearing or otherwise. The commercial loans were backed by liens on the capital assets financed with the proceeds of the loans, and insured by the collateral pledged by the borrower. (Moulton, The Formation of Capital, op. cit., 104.)

Nevertheless, the claim that banks — especially central banks — are stealing from the public by charging interest on the currency persists down to the present day. This accusation is usually made in extremely distorted, even garbled fashion, having become a serious bone of contention as a result of the Panic of 1907 and the Great Depression, and has now achieved the status of unquestioned dogma. The rest of the catalogue of alleged crimes by the government and the banks also echo down to the present day:

• In March 1869 the government had promised to pay off the Civil War debt in coin rather than in greenbacks.

• In July 1870 the government had passed a law changing the national debt into an obligation of the taxpayers, payable in coin.

• At the same time, a law was passed limiting the circulation of greenbacks.

• In February 1873 the government secretly demonetized silver — the "Crime of '73." (One source ludicrously claimed that the government stopped minting silver. Fred A. Shannon, The Farmer's Last Frontier: Agriculture, 1860-1897. New York: Harper & Row, Publishers, 1945, 315.)

• In 1875 Congress passed the Specie Resumption Act, which deflated the currency until it passed at par with gold. (Nugent, op. cit., 16-17.)
The problem, as the populists saw it, was that the country had gotten heavily into debt to finance the Civil War, using the inflated greenback currency. After the war, there was an international conspiracy to steal purchasing power away from working men and women who were, by and large, in debt due to the rapid loss of consumer purchasing power experienced as a result of the inflation. This was being accomplished by deflating the currency until it could be restored to its prewar value and pass at par with gold. The stated reason for the deflation was to restore the credit of the United States with foreign governments. This would force the country into the power of the Jews, who formed a cabal of international bankers who controlled money, credit, and banking throughout Europe and its colonial empires, and wished to bring the United States under their control.

The ordinary citizen-taxpayers were thereby burdened with paying off inflated debts with deflated, more expensive dollars. This put them into permanent servitude to the banks, especially the National Banks responsible for charging double interest on the national debt. The populist solution was to reinstitute "free coinage" of silver, that is, the policy that all silver brought to the mint would be coined into silver dollars on demand. Because silver was cheap and plentiful, this would cheapen (inflate) the money again, raise prices and wages, and create jobs.

The Case for Deflation

Of course, the argument was not entirely one-sided. For their part, those who opposed the populist position (for whom, unless we want to descend to name-calling, we don't have a label) were convinced that the continued existence of the United States government required restoration of the nation's credit. Their rallying cry was "honest money." (Ibid., 18) In strict conformity with the dictates of the British Currency School, embodied in Sir Robert Peel's Bank Charter Act of 1844 and the United States National Bank Act of 1863 (amended 1864), the only way to do this was to control inflation.

The most basic tenet of the British Currency School was that paper money, regardless how issued, automatically causes inflation. The only question was how much paper to issue in order to keep inflation within tolerable limits, or how to manipulate inflation to obtain desired results. The only way to control inflation was not (in accordance with the quantity theory of money) to increase production, but to take paper currency out of circulation to the maximum degree possible. This required strict State regulation of the amount of currency in circulation, which, in turn, meant that the State had to be able to create or destroy money at will by backing banknotes with government debt. In this system, only gold, gold-backed banknotes, and banknotes backed by government debt constituted "real" money.

To reduce or even eliminate inflation and put the United States back on a sound financial footing, the non-gold currency in circulation therefore had to be replaced with gold and gold-backed banknotes that could be converted to gold on demand. As George S. Boutwell, Secretary of the Treasury in 1873, recalled in his memoirs,

In 1873 I had come to believe that it was wise for every nation to recognize, establish, and maintain the gold standard. I was of the opinion then, as I am of the opinion now, that nations cannot escape from the gold standard in all interstate transactions. . . . The choice of gold as the standard was not due to hostility to silver or to the silver mining interests, but to the well grounded opinion that gold was a universal currency, while in some countries, as in England or Germany, silver coins were not a debt-paying currency. . . . The measure was in accord with my policy, and it was in accord with the unbiased judgment of the commissions. (George S. Boutwell, Reminiscences of Sixty Years in Public Affairs. New York: McClure, Phillips & Co., 1902, II:151-152, quoted in Nugent, op. cit., 19.)
A Non-Conspiracy

The presumed conspirators against silver completely rejected the accusation that they had carried out their program in secret. Congressman (later Senator) John Sherman of Ohio (1823-1900) — the "Ohio Icicle," principal author of the Sherman Anti-Trust Act — had his vehement denial read into the Congressional Record in 1893, when the effective demonetization of silver had been resurrected as a critical issue, twenty years after the event. As Sherman declared, "In every stage of the bill and every printing, the dollar of 412-1/2 grains [of silver] was prohibited, and the single gold standard recognized, proclaimed, and understood. It was not until silver was a cheaper dollar that anyone demanded it, and then it was to take advantage of a creditor." (Congressional Record, XXV (August 30, 1893), 106, quoted in Nugent, op. cit., 18.) As one authority summed up the conflict,

Neither side was totally out of touch with reality. The country had to have credit, and in an age when a very substantial portion of the public bonds had to be sold on foreign markets, the intangible reality called investor confidence had to be guarded integrally, for it was crucial. On the other side, people did not join the Farmers' Alliance and the Populist party or vote for Bryan and free silver in 1896 because they were muckers [obsolete slang term for a slum-dweller or low-born laborer] or out for a cheap buck; nearly two-thirds of the American population was rural in 1890, and economic stringency among farmers was maddeningly real. The leading spokesmen on each side, moreover, repudiated the more extreme accusations that some of their own allies made. Though the Eastern press denounced free silver (as it had denounced greenbackism years before) as anarchy, communism, a criminal conspiracy hell-bent on destroying the Republic, Senator Sherman and other responsible leaders distinguished carefully between free-silver doctrine and the people who accepted it: hate the sin, but love the sinner. (Nugent, op. cit., 20.)
Both sides clearly believed they were right. In a sense, they were — to the extent that each took a similar view of money: "money" and "currency" were equivalent terms. The struggle was over whether an inflated or deflated currency would best serve the needs of the country. Thus, while each side was convinced that the other was wrong about the nature of money, what they differed on was monetary policy. Both sides seemed unaware of the fact that "money" does not consist solely, or even primarily of banknotes and coin, but of anything that can be used to settle a debt.

The apparent collision between the British Currency School and populist politics that shook the United States to the core twice in the late 19th century (Ibid., 21) was thus based on a fundamental misconception. The most astonishing part of the whole affair is that both sides agreed on what they believed to be the real issue — and both were 100% wrong: that it is possible to have a sound or even viable economy when the critical link between money and production is broken. The entire fight was over which interpretation of that misconception would benefit the country most.

Growing Concentration of Ownership

Adding to the fight, although largely unnoticed at the time, was the growing concentration of ownership of the means of production. The Homestead Act had slowed this movement slightly, but only in land — and the murder of "nesters," as homesteaders were pejoratively termed by the large ranchers, was not uncommon when a homesteader filed on land to which a large landowner believed he or she had a better claim, controlled the local law, or had more guns.

The increasingly important industrial and commercial sectors of the economy were left untouched. It was the age of the "Robber Barons." These industrial and commercial magnates used their growing wealth and power seemingly exclusively to gain increasing amounts of yet more wealth and power — and that meant that monopolies and trusts were rapidly becoming the order of the day. In a seeming affirmation of the theories of Walter Bagehot, the economic oligarchy that really ruled England (not to be confused with "The Upper Ten Thousand" that ruled society — briefly and unsuccessfully in the U.S. limited to "The Four Hundred" centered in New York City) completely controlled money and credit.

Exclusivity and elitism were the order of the day, an economic and social Darwinism that devastated American life. With the closing of the land frontier, conditions in the ever-expanding industrial frontier became increasingly intolerable. The fact that many factory workers were former soldiers who had lived through the bloodiest war in American history made recourse to violence a seemingly viable alternative. They had fought to free the black slaves, and saw no reason why wage slaves should continue to be subjected to inhuman conditions in the factories.

The Socialization of America and Europe

Consequently, after a somewhat slow start, socialism was starting to gain ground rapidly. The Socialist Labor Party was founded in 1876 in Newark, New Jersey. Party membership was largely new German immigrants, who imported Marxist ideals. While the party platform was initially a grab-bag of all the different varieties of socialism, by 1890 Marxism established its ascendancy, and the party reconstituted as a Marxist party. The philosophy became somewhat more coherent, and their influence expanded rapidly. By 1900 the Socialist Labor Party was the leading socialist organization in the United States.

The predominant socialist ideology in the United States was what has become called "democratic socialism." The desired goal was to give workers control of the means of production by transferring ownership of capital from capitalists, to those who presumably created all the wealth. This, of course, fits in perfectly with Karl Marx's definition of socialism as "the abolition of private property." (Karl Marx and Friedrich Engels, The Communist Manifesto, 1848.) This is because "property" and ownership consist of the right of control and the right to receive the "fruits of ownership," that is, the income generated by what is owned. Despite the peaceful claims of modern socialists, the movement was involved in riots and strikes, notably the infamous Haymarket Riot of May 4, 1886 in Haymarket Square in Chicago, and the Pullman Strike in Pullman, Illinois, in 1894.

If both socialism and the problems it attempted to address were bad in the United States, matters were much worse in Europe. Socialism in Europe was closely associated with anarchism and atheism. Most especially, of course, socialism was a direct attack on the institution of private property, the foundation of a stable social order. The real problem that the socialists tried to address, of course (albeit in a misguided way), was not private property per se, but the problem associated with too few people having the means to participate in the institution. As G. K. Chesterton was to point out later, "Too much capitalism does not mean too many capitalists, but too few capitalists." (G. K. Chesterton, The Uses of Diversity (1921).)

New Things

The twin problems posed by both capitalism and socialism were the starting point of what many people of all religions consider one of the greatest wake-up calls to sanity in the 19th century. This was the encyclical, Rerum Novarum, "On Labor and Capital," which was issued in 1891 by Pope Leo XIII to address the "new things" (the translation of "rerum novarum") that had developed with the rise of industrial capitalism and the jettisoning of Say's Law and the real bills doctrine.

Arguably the first "social encyclical," Rerum Novarum analyzed current conditions for ordinary people, many of whom lacked any degree of ownership of the means of production. In a surprising and revolutionary turn of events, Rerum Novarum went beyond previous encyclicals by not only explaining what was wrong with the economic system, but by pointing out the obvious remedies.

The most important remedy to the propertyless condition was to make certain that people became owners. This was so important that the pope declared, "We have seen that this great labor question cannot be solved save by assuming as a principle that private ownership must be held sacred and inviolable. The law, therefore, should favor ownership, and its policy should be to induce as many as possible of the people to become owners." (Leo XIII, Rerum Novarum ("On Capital and Labor"), 1891, § 46.)

As we have seen was the case with the Homestead Act, widespread direct ownership of the means of production restores the operation of Say's Law. The Homestead Act, however, only addressed land, and thus resulted in only a partial restoration. Leo XIII addressed all forms of productive wealth, arguing, in effect, for a full restoration.

Nor was the goal of turning workers into owners to be achieved in any way that violated any else's rights. If "private ownership must be held sacred and inviolable," that meant for everybody, rich and poor alike, without distinction. A right that is a right only for some of the people some of the time cannot truly be said to be a right at all. When Leo XIII stressed over and over that private property is a natural right, then, he was making it very clear that redistribution of that which belongs by natural right to others is simply not an option — regardless how much someone else thinks they deserve it.

A basic principle of a well-run common good is that no one can have his or her life, liberty, or property taken away without just cause and without due process. Further, consistent with the philosophy of St. Thomas Aquinas (whom the pope had previously stated was the guiding philosophy for understanding the teachings of the Catholic Church), redefining a natural right or the exercise thereof so that the right itself is negated is neither just cause nor due process. (Rerum Novarum, op. cit., § 4.)

In response to the socialists, Leo XIII set out the natural right to be an owner very clearly: "Every man has by nature the right to possess property as his own. This is one of the chief points of distinction between man and the animal creation," (Ibid., § 6) as well as an equally clear exposition of what an owner can do with what he or she possesses, that is, the right of control and — most important for the restoration of Say's law — of disposal. (Ibid., § 5.) Why is "disposal" of property important for Say's Law? Because the power to draw a bill on the present value of what one owns, whether existing or future marketable goods and services, constitutes "disposing" of it.

Still Bound to Past Savings

The pope, however, made a tactical error in the encyclical. Leo XIII failed to take into account the fact that, consistent with the assumptions that have plagued the human race for thousands of years about how capital formation is financed, a great many experts and analysts would go unerringly off course. The inevitable tendency on the part of the usual authorities (inside and outside the Catholic Church) would be to take the pope's clear and unequivocal statements about private property and the natural right of everyone to be an owner of capital, and automatically assume the pope was calling for socialist redistribution or a continuation of monopoly capitalism. These are, in fact, the only possible alternatives if we limit ourselves to assuming that capital formation can only be financed out of existing accumulations of savings, regardless of our commitment or lack thereof to expanded capital ownership.

Not surprisingly, that is precisely what happened. The socialist read socialism in Rerum Novarum and all subsequent encyclicals, while the capitalist, to no one's surprise, saw an endorsement of capitalism. Trapped irrevocably in the belief that capital formation cannot be financed without recourse to existing accumulations of savings, both capitalists and socialists naturally ended up right back where they started.

Even Henry George weighed in on the debates stirred up by Rerum Novarum. In a 30,000-word "open letter" to Leo XIII, The Condition of Labor, (Henry George, On the Condition of Labor, September 11, 1891.) George did not, however, debate the issue so much as state his disagreement with Catholic teaching on private ownership of land and natural resources. To be fair, although not a Catholic, George was extremely polite and much more respectful of the Holy See than even many Catholics. George found himself able to agree on many of the teachings found in Rerum Novarum, and certainly all of the goals that Leo XIII said were desirable, even necessary.

George, however, disagreed strongly with the traditional teaching of the Catholic Church, based on the natural law that applies to the whole of humanity, that individuals as individuals have a natural right to own land and natural resources. Because George traced the problem of poverty and virtually all other social and economic ills to private property in the limited resources of land and natural resources, this meant that the Catholic Church was, in his opinion, failing to address the real cause of poverty.

To this day there are people who believe that Rerum Novarum either unfairly or unwisely dismisses socialism as the only viable alternative to capitalism, or creatively reinterpret the strictures against socialism in the encyclical to turn it into an endorsement of socialism. The only people possibly more active than the socialists in attempting to distort the natural law understanding of private property and the need for widespread ownership of the means of production are the capitalists.

Thus, despite the flaws that Leo XIII could see in the system as it existed in 1891, there was no real appreciation of the remedy: widespread direct ownership of the means of production. This was, as we have seen, both a systemic and a theoretical problem caused by adherence to the tenets of the Currency School and the consequent rejection of Say's Law and the real bills doctrine.

Does this mean that the pope or the Catholic Church is to blame for what was soon to come? Hardly. Catholics believe the pope to be infallible — but only in matters of faith and morals, and then only when teaching something intended to be understood as infallible. Applications of economic theory, while necessarily based on moral absolutes, are not themselves absolutes.

For example, the principle that every human being has the natural right to be an owner is absolute, and was stated as such by Leo XIII. How people are to exercise that ownership, and (more important with respect to the objective of restoring Say's Law) how they are to gain that ownership is a matter for human judgment — and human beings can be wrong.

Thus, when forty years later Pius XI reemphasized the importance of workers becoming owners, he was simply repeating an application of an infallible moral absolute: the natural right every human being has to be an owner of the means of production. (Quadragesimo Anno ("On the Restructuring of the Social Order"), 1931, §§ 58-59) He then made a human — and, frankly, flawed — judgment as to how workers were to acquire ownership: cut consumption, accumulate money savings, then invest. (Ibid., § 61) The papal encyclicals at one and the same time stressed the importance of the restoration of Say's Law as a moral imperative, then inserted a fallible human judgment that, if adhered to, made the restoration of Say's Law impossible.