Money Power (Part 1)
“Money makes the world go round.” Most people have heard this phrase at one time or another in their lives. It reflects our general consensus regarding the importance of money as a source of power required to get things done in this world. On the other hand, we’re told that “money doesn’t grow on trees.” This saying reflects the broad belief that money isn’t abundant and can be hard to come by, although it doesn’t say anything about the source of the power needed to produce it. Then, a popular alternative version to the golden rule holds that “he who has the gold makes the rules.” This reflects widespread recognition that money is not distributed equally and those with more have power over those with less. The links between money and power are fascinating, but as these well-worn clichés suggest, we have come to take a number of things for granted without really understanding the underlying dynamics associated with the power of money and the money power.
To better understand the nature and role of money in modern society, this discussion is divided into two parts. This first part provides a brief historical overview of the emergence of the institution of banking, beginning with an explanation of the emergence of interest-based fractional reserve banking and the problems associated with its institutionalization as standard banking practice. This is followed by a quick look at the history of central banking in this country, from the first Bank of the United States to the founding of the Federal Reserve. This history is then reconsidered in terms of a struggle by the money power – the dominant European and American financiers – to gain control over the American monetary system.
The second part of the discussion (look for this in February) will consider the nature of the world’s monetary system in the 20th century. This includes an overview of the development and collapse of the Bretton Woods systems, as well as an explanation of how fiat money, “petrodollars,” and the dynamics of the “global casino” have created a monetary/financial/economic system that is no longer tenable. Ultimately, the intent of this analysis is to provide a better understanding of the true nature of money and the money power that has led modern society literally to the brink of economic collapse.
Two caveats are in order. First, in order to cover this much ground, the discussion is necessarily cursory. Relevant information will be presented, but usually without much explanation or elaboration. To the extent any of this information is surprising, if not disturbing, I would certainly encourage further investigation of the matter to gain a fuller understanding of the specifics in question. Second, money is a more complex topic than one might realize, and while I have proactively tried over the last ten-plus years to become better informed about the topics addressed below, my own understanding of how the monetary system functions remains limited. Thus, if there are any factual errors or misinterpretations in this material, I would be happy to have my understanding of these matters corrected and improved.
As a medium of exchange, money has taken a variety of forms through the ages, including shells, stones, feathers, and tally sticks. However, as a store of value, money has typically taken the form of coins comprised of precious metals, usually gold and silver. In centuries past, wealthy individuals who accumulated lots of gold or silver found it convenient to store it for safekeeping with a goldsmith, who would issue paper receipts to the owner that could be redeemed for the metal at some point in the future. Moreover, since carrying coins for use in transactions could be inconvenient and/or potentially risky, the practice arose of using the paper receipts instead to conduct business. Given the option of redeeming these receipts for actual gold or silver upon demand, the use of paper notes became an effective form of money that served as both a medium of exchange and a store of value.
As paper receipts became readily accepted as money, those who stored their metal with a goldsmith oftentimes did not need access to it for long periods of time. This enabled the goldsmiths to go into the lending business, as they could loan out some of the gold and silver they had in storage based on the assumption that it would be repaid before its owner needed access to it again. Furthermore, with paper replacing the metal itself as the medium of exchange, goldsmiths didn’t need to lend out the actual gold and silver to borrowers but could lend out paper receipts instead. Since there was little demand to exchange the receipts for metal, given the convenience of the former, the goldsmiths ultimately realized that they could issue and lend out more receipts than there was actual gold and silver in their vaults. This practice enabled them to become very wealthy simply by manipulating the reserves of other people’s money.
Over time, the role of the goldsmiths evolved into the banking industry, and the process of lending out more money than is kept in reserves has been institutionalized in the practice of fractional-reserve banking. In simple terms, this refers to the fact that banks are required to hold in reserve only a fraction of the total deposits their customers have made, meaning they can use the remainder of those deposits to engage in other money-making activities just as the goldsmiths cleverly learned to do in earlier times. The obvious risk in a fractional-reserve system is a bank run, when many customers want to withdraw their deposits at the same time such that the bank’s reserves cannot satisfy the total demand. An important role of central banks is to help reduce this risk by managing a nation’s money supply and regulating key aspects of its banking system (e.g., interests rates and reserve requirements) so as to insure adequate liquidity to meet the needs of the economy as a whole.
A significant consequence of this fractional-reserve system is that commercial banks essentially have the power to create new money through the process of making loans. When a customer takes out a mortgage or a car loan from a bank, the bank makes two new accounting entries in its books: one is an asset in the form of the promissory note the customer signs promising to repay the loan, and the other is a liability in the form of a credit into the borrower’s deposit account (that is then used to purchase the house or car). Basically, each time the bank loans money, it is adding to the supply of money available in the economy while simultaneously adding to the total debt in the economy. As explained in a report from the Bank of England, “When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created…Money today is a form of debt, but a special kind of debt that is accepted as the medium of exchange in the economy. And most of that money takes the form of bank deposits, which are created by commercial banks themselves.” In short, through the standard practices of the commercial banking system, the economy is fueled by an ever-increasing supply of money created as debt.
“If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash, or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible – but there it is” (Robert Hemphill, Credit Manager of the Federal Reserve Bank in Atlanta, in the foreword to the book 100% Money by Irving Fisher, 1936).
A fundamental flaw in this system is that all the debt created by the banks is supposed to be repaid with interest, even though the volume of money they create is sufficient only to repay the principal. For much of human history, the practice of charging interest on loans – what used to be called usury – has been viewed as problematic. In their review of the historical critique of usury, Wayne Visser and Alastair McIntosh document criticism and/or prohibition of usury in most of the world’s major religions as well as in both ancient western philosophy and modern reformist thinking. They point out that this criticism has been based on moral, ethical, religious, and legal grounds. These include the arguments that usury exploits the needy, leads to an inequitable redistribution of wealth, generates economic instability, and discounts the future. Usury was seen as a mortal sin and prohibited throughout Christendom until the Reformation period, after which the emergence of the banking industry helped to legitimize the practice of charging interest on loans. Eventually, the word usury was redefined to mean excessive or exorbitant interest, i.e., more than what is considered acceptable or appropriate, which historically has been a rate of about 6-12 percent.
One problem with interest is that it is essentially unearned income, differentiated from profit earned through a definite value-creating process, and reflecting a conception of money as an end in itself rather than as a means of facilitating trade. If there is any logic for charging interest on a loan of someone else’s money, the rationale makes little sense when the money is created through a bookkeeping entry or use of a credit card. A second problem is that interest charges inherently result in a situation of monetary scarcity, since there is not enough money created to repay all the principal-plus-interest associated with the debt incurred in the creation of the money. This creates a situation of competition for access to scarce working capital, inevitably resulting in economic winners and losers and thereby undermining the collective well-being of society. Conversely, it also incentivizes the creation of even more money/debt, to make it possible to repay previous debts along with accrued interest. But continued expansion of the money supply has inherent inflationary effects that serve to reduce the value of that money over time. Finally, interest is problematic in that it enables a massive transfer of wealth from the masses to the money lenders. Given the costs of capital diffused throughout the economic system, it has been estimated that about 40 percent of all consumer prices can be traced backed to these costs, resulting in a huge amount of unearned income for the planet’s usurers.
As H. W. Brands explains in the Prologue to his book The Money Men, “a single question vexed American politics and the American economy more persistently than any other” for the first five generations of this nation’s history. This was “the money question,” or the question of what constitutes money in the United States, which raised the additional questions of how much money there shall be, who ought to control it, and to what ends?
The formation of this country as a federation of independent states took place in the midst of a contest between those who wanted a strong national government and those who preferred keeping most of the power in the state governments, closer to the people themselves. While Thomas Jefferson is best known as the strongest advocate for the populist view, history identifies Alexander Hamilton as the primary proponent of a central government dominated by the aristocratic elite. Hamilton admired the British monarchical system of government, and wanted to incorporate elements of that system into the American constitution. However, the monarchists were unable to convince George Washington to take on the role of king, and strong support at the Constitutional Convention for states’ rights and republican government led to a constitution that did not include many of the institutional features that Hamilton had advocated.
After President Washington appointed Hamilton as the first Secretary of the Treasury, he continued to advocate for a strong national government and argued that the “implied powers” of the constitution provided the authority for a government-owned national bank that would help stabilize the nation’s economy and improve the handling of the new government’s financial business. He believed the country would benefit from the establishment of a central bank modeled after the Bank of England, which had been founded in 1694 after William of Orange took the English crown from King James II a few years earlier. William was a Dutch sovereign, and it was in Amsterdam during the 17th century that fractional-reserve banking had developed and matured following the founding of the Bank of Amsterdam in 1609. While Hamilton wanted to establish a similar central bank for the new United States, Jefferson opposed the idea, arguing that it was unconstitutional as well as an engine for speculation, financial manipulation, and corruption. Despite this opposition, Hamilton secured Washington’s consent to sign the bill passed by Congress that authorized the first Bank of the United States, chartered for twenty years from 1791 to 1811.
Congress did not renew the Bank’s charter in 1811 when the bill failed to pass by a single vote. However, the War of 1812 began right away the next year, resulting in mounting pressure for a new national bank that would enable the government to fund an expensive war effort as needed. The outcome was Congressional authorization of the Second Bank of the United States, founded in 1816 and chartered for another twenty years. But when populist president Andrew Jackson took office in 1929, he quickly started to challenge the Bank and its constitutionality, reflecting the belief he shared with Jefferson that it served the interests of the privileged class rather than those of the common folk. The continued existence of the Bank was the key issue in Jackson’s re-election campaign in 1832, and when the voters put him back in office for a second term, he interpreted this as a mandate to close the bank. In September of 1833, he removed all federal funds from the Bank, and Congress subsequently voted not to renew the Bank’s charter.
The years from 1837-1862 are now referred to as the “free banking” era, as there was no central or national bank and only state-chartered banks were operating. Each bank could issue its own currency notes in whatever volume it wished, creating no small amount of chaos as the size of the money supply and the relative value of the various currencies fluctuated greatly throughout this period. In 1862, needing funds to pay for the Civil War, Lincoln eschewed the bankers’ demand for 24-36 percent interest on loans and instead got Congress to pass a bill, the first Legal Tender Act, authorizing the printing of legal tender treasury notes – the “greenbacks” – to serve as a new national currency. Unlike private and state banknotes, there was no pretense that the greenbacks were redeemable in gold or silver; instead they were a “fiat” currency approved as an emergency measure to support the war effort. Congress subsequently passed additional legislation, the National Bank Acts of 1963 and 1964, that established a system of national banks chartered by the federal government and regulated by the U.S. Treasury Department. A primary purpose of this legislation was to develop a national currency backed by bank holdings of U.S. Treasury securities, thereby pushing the notes issued by state and local banks out of circulation and bringing greater stability to the nation’s monetary system.
The national bank system functioned in lieu of a central bank until early in the 20th century, with considerable volatility during this period in the form of a financial crisis or panic every decade or so. Finally, the Panic of 1907 – a three-week financial crisis involving bank runs and bankruptcies across the country – stimulated new calls for a central bank to bring stability to the nation’s financial system. This crisis might have been even worse had J. P. Morgan and other financiers not used some of their own personal resources to prevent further contagion and collapse. To consider how to avoid similar circumstances in the future, Congress established the National Monetary Commission the following year to investigate the crisis and recommend potential solutions. After studying European banking systems, the chair of the Commission – Senator Nelson Aldrich, father-in-law of John D. Rockefeller, Jr.– convened a number of the leading financiers in the U.S. to draw up plans for a new central bank. Following considerable debate and modification of this proposal, Congress passed the Federal Reserve Act on December 23, 1913. The third central bank for the United States of America (actually a system of banks) has now lasted for over 100 years.
What this brief overview only hints at is the significant conflict that existed, at the time of the American Revolution and throughout the first century of this country’s development, between the money power – the European banking interests – and American leaders who wanted to help their new country avoid coming under the influence of those bankers. An important decision raising the ire of the American colonists and stoking the fire of revolutionary sentiment was the Currency Act of 1764, passed by the British Parliament to make it illegal for the colonies to issue and utilize their own scrip, or paper currencies. Whereas use of their own currencies had enabled the colonies to prosper, with very little poverty, the Currency Act required them to rely exclusively on banknotes issued by the Bank of England, and to pay their taxes using gold or silver coins. This led fairly quickly to a significant reduction of the money supply in the colonies, along with the inevitable economic contraction. Ultimately, the rebellion against King George III may have been provoked more by these constraints on the colonies’ monetary system than by their disgruntlement over “taxation without representation.”
One problem with interest is that it is essentially unearned income, differentiated from profit earned through a definite value-creating process, and reflecting a conception of money as an end in itself rather than as a means of facilitating trade.
Whereas colonial scrip had simply been spent or issued into existence by colonial governments, with an appropriate supply made available to match the needs of a growing economy, Bank of England bank notes were lent into existence, meaning they were given to the government in exchange for interest-bearing securities, with the interest being paid out of tax revenue collected from the people. Since colonial scrip did not require any such interest payments, the wealth produced through the labor of the colonists essentially stayed in their hands, rather than a portion being transferred to the coffers of the bankers. Once the Revolutionary War was won, and the founding fathers were tasked with writing a constitution for the new United States, they gave express power to Congress (in Article 1, Section 8, Clause 5) to “coin Money, regulate the Value thereof, and of foreign Coin.” Alexander Hamilton argued that Congress therefore had the implied power to establish a central bank to help fulfill this function, but Thomas Jefferson disagreed and was leery about turning control of the nation’s money supply over to European bankers.
“I have ever been the enemy of banks…My zeal against those institutions was so warm and open at the establishment of the Bank of the United States, that I was derided as a maniac by the tribe of bank-mongers, who were seeking to filch from the public their swindling and barren gains” (Thomas Jefferson to John Adams, 1814).
Since the revolutionaries had learned from personal experience that economic conditions in the country were directly related to the supply of money and thus the availability of cash and credit for people to use, many of them were reluctant to give that power to foreign bankers who had no loyalty to the new nation but instead were clearly focused on serving their own financial interests. Furthermore, in contrast to a government-issued scrip that was created without any corresponding debt, it made little sense to them to rely instead on a bank-issued currency that required payments of interest that directly transferred wealth from the public into the private hands of the bankers. Despite this resistance, and even animosity on the part of some, the power of the money power to exert its will was demonstrated by the creation of the first and then the Second Bank of the United States. The subsequent influence the financiers came to exert over the government, and the corruption inherent in the subversion of a democratic system to serve the interests of the rich and powerful, ultimately motivated Andrew Jackson’s successful crusade to get rid of the central bank.
“It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes…(W)hen the laws undertake…to grant titles, gratuities, and exclusive privileges, to make the rich richer and the potent more powerful, the humble members of society…have a right to complain of the injustice of their Government…Many of our rich men have not been content with equal protection and equal benefits, but have besought us to make them richer by act of Congress… If we can not at once…make our Government what it ought to be, we can at least take a stand against all new grants of monopolies and exclusive privileges, against any prostitution of our Government to the advancement of the few at the expense of the many…” (President Andrew Jackson’s message to the Senate vetoing the renewal of Second Bank of the United States, 1832).
Without a central bank in place, and with American economic power growing during the free banking era, the European elite were concerned that an independent United States could grow so strong that it would eventually come to dominate the powerful Old World countries. It is not surprising, then, that, when civil war broke out in America, they sympathized with the Confederacy and were willing to help them raise money to support the war effort, for example, through the ill-fated issuance of cotton bonds. The Union also needed funds to pay for the war, and Lincoln tried to avoid borrowing from the usurious bankers by issuing greenbacks which, like the colonial scrip that King George had outlawed, were issued by the government debt-free. However, since the greenbacks were fiat money, not backed by gold or silver, as more and more of them were put into circulation, the resulting inflation led them to quickly lose their value. To address this problem, the National Bank Acts re-established the international bankers’ role in America’s monetary system, ostensibly to bring stability to the financial and economic conditions in the country through the use of a debt-based currency, i.e., bank notes backed by interest-bearing securities issued by the U.S. Treasury.
A second problem is that interest charges inherently result in a situation of monetary scarcity, since there is not enough money created to repay all the principal-plus-interest associated with the debt incurred in the creation of the money.
Instead, however, there was considerable volatility throughout the remainder of the 19th century, with panics in 1873, 1884, and 1893 preceding the Panic of 1907. To a considerable extent, economic volatility is a function of changes in the supply of money and access to credit in an economy, the authority and responsibility for which rested in the hands of the national banks. Since banks are able to make good profits on both sides of the economic boom-and-bust cycle – lending more and making profitable investments when times are good, foreclosing and taking ownership of collateralized property when times are bad – they have as much interest in generating volatility as in maintaining stability. Furthermore, fractional reserve banking by definition creates the conditions in which bank runs are a risk, and the intermittent panics demonstrated by the American public were reasonable responses to a banking industry and wealthy financiers that pushed their profit-seeking activity beyond a point that the system could tolerate. Bubbles created by speculative investments inevitably imploded, leading to economic depressions that, even back then, had long-term international consequences.
By the turn of the century, the public had indeed become wary of the money power. The wealth accumulated by the great industrialists and robber barons of the day, and the consolidation of organizations and industries into large “trusts,” fueled a considerable amount of anti-trust sentiment and legislation intended to limit the power of these tycoons. In the aftermath of the Panic of 1907, public support for revising the national banking system to help forestall future economic chaos was balanced by public concern about giving any more power to the elite financiers. This suspicion led a small group of top bankers, at the behest of Senator Aldrich, to take a secretive train ride from New Jersey to Georgia in 1910 where they gathered for a week at J. P. Morgan’s private resort on Jekyll Island. Representing the dominant financial interests of both the U.S. and Europe – Morgan and Rockefeller, the Rothschilds and the Warburgs – the purpose of this group, as explained by G. Edward Griffin in The Creature of Jekyll Island, was essentially to come to an agreement on the structure and operation of a banking cartel that would serve the function of a central bank for the country.
“I do not feel it is any exaggeration to speak of our secret expedition to Jekyll Island as the occasion of the actual conception of what eventually became the Federal Reserve System…If it were to be exposed publicly that our particular group had got together and written a banking bill, that bill would have no chance whatever of passage by Congress” (Frank Vanderlip, President of the National City Bank of New York, Saturday Evening Post, 1935; quoted by Griffin).
Griffin suggests that, in coming up with their plan, the group made an effort to choose a name that would make the concept more palatable to the public, for example, avoiding use of the word “bank,” implying a connection to the federal government, and making it a system of banks rather than concentrating power in one single bank. Paul Warburg was the member of this group who exerted the most influence on the design of the system they proposed, as he had the most expertise regarding the European model of central banking. Warburg was a leading European banker who had been in the U.S. for only nine years prior to this clandestine meeting, and he was already well known on Wall Street by that time as a persuasive advocate for a central bank in America. After the Democrats regained control of Congress in 1910 followed by Woodrow Wilson’s election to the Presidency in 1912, the bankers’ proposal was modified in important ways to reflect the Democrats’ populist orientation and inherent distrust of the “money trusts.” With key features of their plan still in place, however, the Federal Reserve Act was passed by Congress and signed into law by President Woodrow Wilson right before Christmas in 1913.
“This [Federal Reserve] Act establishes the most gigantic trust on earth. When the President signs this bill, the invisible government of the monetary power will be legalized….the worst legislative crime of the ages is perpetrated by this banking and currency bill” (attributed to Congressman Charles A. Lindbergh, Sr., 1913).
Since then, control of the monetary system of the United States of America has been in the hands of a consortium of private banks and bankers who profit as a consequence of having this control. Whereas the express power granted to Congress to coin money and regulate its value reflected the founding fathers intent for the government – and thus the people – to maintain control of the monetary system, the Federal Reserve Act essentially out-sourced this function to a powerful group of international financiers charged with operating this banking system to serve the public interest. Despite signing the bill into law, the President expressed his dismay about the privatized concentration of monetary control.
“(T)here has come about an extraordinary and very sinister concentration in the control of business in the country. However it has come about, it is more important still that the control of credit has also become dangerously centralized. It is the mere truth to say that the financial resources of the country are not at the command of those who do not submit to the direction and domination of small groups of capitalists who wish to keep the economic development of the country under their own eye and guidance…A great industrial nation is controlled by its system of credit. Our system of credit is privately concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men who, even if their action be honest and intended for the public interest, are necessarily concentrated upon the great undertakings in which their own money is involved and who necessarily, by very reason of their own limitations, chill and check and destroy genuine economic freedom” (Woodrow Wilson, as quoted by Thomas Greco in The End of Money and the Future of Civilization).
The institutionalization of the money power in the American economy by the Federal Reserve Act was just the beginning of the evolution of the power of money during the 20th century. These developments will be discussed in Part 2, in an effort to provide a better understanding of the predicament now facing the global economy.
Finally, interest is problematic in that it enables a massive transfer of wealth from the masses to the money lenders.
The opinions expressed are those of the author, and do not reflect in any way those of the USC Bedrosian Center.