On May 22, 2013, the Wall Street Journal published an op-ed piece by Phil Gramm and Steve McMillin, “The Debt Problem Hasn’t Vanished.” We thought it was pretty good — except that the authors assumed as a given that the currency had to be backed by government debt.
Naturally, we couldn’t let that pass unchallenged, so we sent the following letter. It must have been pretty good, for Mr. McMillin sent us back a brief note commenting favorably on our insightful analysis. Maybe there’s still hope to turn things around and return to a currency backed with private sector hard assets instead of government debt:
Phil Gramm and Steve McMillin’s piece, “The Debt Problem Hasn’t Vanished” (WSJ, 05/22/13, A15) echoes the warnings of Henry C. Adams in the 19th century and Harold G. Moulton in the 20th. Gramm and McMillin’s analysis, however, assumes that paying down government debt necessarily means a shrinking money supply.
“Money” and “currency” are not equivalent terms. Mass consumption power and small business and agricultural development in the 19th century was tied to the deflating bank note currency. At the same time, industrial and commercial interests could create money at will in the form of demand deposits and commercial paper by discounting and rediscounting bills of exchange at state and National banks.
The increase in personal real income and decrease in the wholesale price level was, as Gramm and McMillin point out, due to increases in productivity unmatched in history. This was fueled by the synergy of the Homestead Act and rapidly advancing technology.
The discontinuity between production and consumption power resulted in financial panics and subsequent depressions in 1873 and 1893. Centralized control of the financial system, failure to separate commercial from investment banking, stock market speculation, and an inadequate clearinghouse and reserve system caused “the Bankers’ Panic” of 1907, and renewed demands for reform.
The Federal Reserve was established in 1913 primarily to 1) Replace the inelastic government debt-backed National Bank Notes of 1863-1913 and Treasury Notes of 1890 with elastic private sector asset-backed Federal Reserve Notes. 2) Regulate clearinghouse operations. 3) Provide for emergency reserves at need. 4) Decentralize financial power away from New York City by establishing a network of twelve regional central banks.
Political decisions to finance U.S. entry into World Wars I and II and the New Deal using debt instead of taxes diverted the Federal Reserve from its mission to be the lender of last resort for the private sector, and transformed the backing of the Federal Reserve Notes from private sector hard assets to government debt. The Federal Reserve was now construed as the lender of first resort for the federal government.
Adding the contradictory mandates to control inflation and establish full employment to the Federal Reserve’s mission — impossible in any event within the Keynesian framework — confused monetary and fiscal policy to the point of incomprehensibility. In an effort to achieve these and other goals, changes during the New Deal put the Federal Reserve under direct political control, while maintaining its nominal independence.
To solve the debt problem permanently, it is essential to terminate monetization of government debt and increase the tax base by fostering productivity. We can duplicate the quantum leaps in productivity and real income we saw in 19th century America by making ownership of future private sector industrial and commercial capital open to everyone, without redistributing existing wealth.
A “Capital” or “Industrial” Homestead Act, such as President Reagan called for when governor of California, can be financed not by self-defeating and counterproductive redistribution of existing wealth, but by allowing anyone with a qualified and financially feasible capital project, whether agricultural, commercial, or industrial, to discount bills at local commercial banks for rediscount at the regional Federal Reserves. Replacing traditional forms of collateral with capital credit insurance and reinsurance, and bank reserves backed with government debt with reserves backed with private sector hard assets, would take away any justification for having an outstanding national debt of any size.
Yours, blah, blah.