In parts one and two we looked at coin, scrip redeemable in coin and pure scrip. In part three we’ll look at the scrip we use today, Federal Reserve Notes.
To understand what a Federal Reserve Note is it helps to understand what the Federal Reserve is. The short answer is the United States Federal Reserve is a central bank that was chartered into existance in 1913.
FUN FACT Q and A:
- Q) Is the Federal Reserve a branch of the government?
- A) No, it’s a private bank. It’s “owned” by the subscriber banks it serves. A lot has been written on this and it’s an intriguing and murky subject.
- Q) Is the Federal Reserve the first United States central bank?
- A) No, it’s the fourth.
- Q) What happened to the other three?
- A) Good question:
Alexander Hamilton’s Bank of North America, chartered in 1781, was the first and by 1791 it had morphed into the First Bank of The United States. The First Bank of the United States’ charter expired in 1811 with Thomas Jefferson instrumental in blocking the extension of its charter. The debates over central banking between proponent Hamilton and opponent Jefferson is an interesting chapter in monetary history.
- “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”
Thomas Jefferson, (Attributed)3rd president of US (1743 – 1826)
The War of 1812 caused government deficit spending to explode and it wasn’t long before central banking made a comeback with The Second Bank of the United States chartered in 1816.
Andrew Jackson hated the Second Bank of the United States. He saw it as corrupt and was elected President of the United States on a platform of abolishing it. Here’s what he had to say:
“Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves.”
Andrew Jackson, 7th presedent of the US (1829 – 1837)
He survived an assassination attempt and ultimately blocked the renewal of its charter in 1836. Another really interesting chapter in the political, economic, and monetary history of the United States.
- Q) So the United States didn’t have a central bank from the expiration of the Second Bank of the United States’ charter in 1836 until the granting of the Federal Reserve’s charter in 1913?
- A) That is correct, no central bank for 77 years.
- Q) What did the United States use for money during this time.
- A) Prior to 1913 United States money was primarily gold and silver coin and scrip redeemable for coin. The United States treasury also issued legal tender United States Notes.
The passage of the Federal Reserve Act in 1913 came just in time to finance the United States participation in World War 1. The issuance of the new Federal Reserve Notes on top of the existing monetary base inflated the money supply and touched off the roaring 20’s.
So what’s happened since the creation of the Federal Reserve in 1913? Let’s take a look:
- In 1913 Federal Reserve notes were redeemable in gold at $20.00 per ounce.
- By 1933 the United States was in depression and gold was removed from domestic circulation.
- The dollar was then depreciated to $35.00 per ounce of gold for international trade but was never again redeemable for gold domestically.
- By 1965 United States coin was no longer silver.
- In 1968 United States Silver Certificates were no longer redeemable for silver.
- By 1971 the dollar was no longer redeemable for anything but a Federal Reserve Note.
Here’s President Richard Nixon defaulting on the last vestige of any kind of gold standard. It’s an important speech and it’s amusing to see him try and imitate the FDR speech imbedded above. He makes some interesting points and it’s well worth watching.
Today there are no gold certificates, silver certificates, or United States Notes. Except for coin issued by the United States Treasury, money is scrip and digital equivalents issued by the Federal Reserve.
- Q) Where do Federal Reserve Notes come from?
- A) They are borrowed into existence. It’s debtmoney.
Imagine this: The government needs a dollar because it’s spent more than it receives. Raising taxes would be unpopular so what to do, what to do?
- The Treasury goes to the Federal Reserve for a loan.
- The Treasury gives an IOU to the Federal Reserve for a dollar PLUS (key concept) interest.
- The Federal Reserve creates a “dollar” and lends it to the government to spend as they wish.
That’s how a Federal Reserve Note is born, it’s as simple as that. The central bank creates and loans the notes at interest. The debt and the dollar are mutually arising. The auctions and “primary dealers” makes it appear more complicated but it’s really just stagecraft and an opportunity for the subscriber banks (the one’s that own the Fed remember) to make some skim off the setup.
The problem we face now is it’s impossible to borrow ourselves out of debt with more Federal Reserve Notes. Creating more of this kind of money only creates more debt and eventually the interest will crush us. Furthermore austerity, paying back the debt, is by definition deflationary; If you pay all the Federal Reserve Notes back there won’t be any money, and you’d still owe the interest. Nice!
Time for a different monetary system?