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David Wessel on low inflation

by Larry White June 17th, 2014 5:32 pm

Ex-Fed chair Ben Bernanke is currently a resident fellow at the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution. The Center’s director, David Wessel, appeared on NPR’s Morning Edition yesterday to express views on inflation and deflation that are essentially indistinguishable from Bernanke’s.

In particular, like Bernanke, Wessel spoke as though inflation below 2% per annum, and a fortiori deflation, is always bad.

Asked to explain why it should be bad to have less of a bad thing like inflation, Wessel first responded: “I mean it sounds appealing, prices going down, people paying less at the store. But when inflation is low that means wages are going up very slowly too. That's of course not very popular.“ This sort of answer would earn an undergraduate a poor grade from any instructor who emphasizes the distinction between real and nominal variables. Workers should not applaud rising nominal wages per se; what matters for them is their real wages. When inflation is low, so too are nominal wage increases ordinarily. But that says nothing about the path of real wages, which in the long run are not determined by monetary policy.

Wessel continued: "There are a couple of problems with too little inflation. It can be a symptom of a lousy economy, one in which demand for goods and services and workers is anemic."

A key word here is symptom. A condition that can be a symptom of a problem is not the problem itself, and can also appear under healthy conditions. Wessel failed to note that low inflation need not be a symptom of a lousy economy, because he spoke only of variation in the aggregate demand for goods and services. Low inflation (or even deflation) can instead be the benign result of abundant growth in the real supply of goods and services. Under the gold standard, as Atkeson and Kehoe (2004) have reported, periods of lousy economy (recession) were not more common during deflation periods, nor vice-versa.

If the Fed were today targeting the path of nominal income, because the growth rate of nominal income is the sum of the inflation rate and the real income growth rate, low inflation would be a sign of a healthy economy with high real economic growth. Thus Wessel would have provided a more accurate analysis if he had spoken of problems with growth in nominal aggregate demand being weaker than anticipated, not inflation being below its target. (In terms of dynamic AD-SRAS analysis, unexpectedly low growth in AD moves the economy below the natural rate of output.)

Wessel’s second concern is harder to interpret favorably. Low inflation, he said, "can make it hard for the Fed to spur borrowing because it's hard for them to get the interest rate below the inflation rate." Two responses: (a) The Fed should not be trying to “spur borrowing.” Fed efforts to spur borrowing helped to fuel the housing bubble. (b) The Fed is not in fact currently finding it hard to get the interest rate below the inflation rate. The interest rate on 1-year T-bills has been below the CPE inflation rate for more than four years, since 2009’s dip into deflation (in that case due to weak demand for goods following the financial crisis).

Wessel went on the cite the problem of rising real debt burdens in deflation. That can indeed be a problem in an unanticipated deflation (Wessel never distinguished anticipated from unanticipated), but again, only to the extent that the deflation is driven by unexpectedly weak aggregate demand growth and not by robust aggregate supply growth. In the latter case, borrowers have more real income with which to repay.

In his answer to the interviewer’s last question, Wessel declared: “So it used to be that economists believed that a central bank can always create inflation by printing more money. But lately it's been -seems harder to do that than the textbooks had told us.” But what is the evidence that expanding the stock of money does not still generate inflation the way the old textbooks tell us? Surely not the experience of the Fed undershooting its target of 2.0% growth in the PCE by 0.4%, which only implies that the broad money growth rate was 0.4% lower than the rate that would have hit the target. Fortunately or unfortunately, it remains the case that the Fed can always raise the PCE inflation rate by engineering a higher rate of broad money growth, just as the textbooks explain.

By the way, today’s announced number for the May CPI raises year-over-year CPI inflation to 2.1%. The increase of 0.4% over April’s CPI, compounded twelve-fold, implies an annual rate of 4.9%. At this rate the “problem” of an undershooting PCE-deflator inflation rate will be “solved” before long.

(HT to David Boaz)


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New working paper on Bitcoin

by Larry White June 16th, 2014 10:24 am

Will Luther and I have a brief new SSRN working paper entitled "Can Bitcoin Become a Major Currency?"


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Larry White has three recent working papers

by Kurt Schuler June 11th, 2014 10:36 pm

"Free Banking in History and Theory"

"The Troubling Suppression of Competition from Alternative Monies: The Cases of the Liberty Dollar and E-Gold"

"The Merits and Feasibility of Returning to a Commodity Standard"

And why the heck do I have to be the one to post about them? Come on, fellow bloggers, if you write a relevant paper, spare the two minutes to post a notice of it yourselves.


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Other people's work

by Kurt Schuler June 2nd, 2014 11:18 pm

Vern McKinley will be speaking at the Cato Institute on June 4 at an event titled "Run, Run, Run: Was the Financial Crisis Panic over Bank Runs Justified?" The event will also be streamed over the Internet live and can be replayed on video later. If the Velvet Underground reference was intentional, Vern, I like it.

Larry Parks had an article called "Bitcoin's Futile Quest to Be a Currency" in the Wall Street Journal. (To be clear, Parks is not opposed to Bitcoin trying to be a currency; he says that rules adopted in March by the U.S. Internal Revenue Service stand in its way.)

Mark Spitznagel had a book that was published in 2013 but that I only found out about today, The Dao of Capital: Austrian Investing in a Distorted World. Here is a transcribed conversation between Spitznagel and Nassim Taleb that touches on the book, which I have not read.

Finally, The Gold Standard Now has begun to post the complete records of the Reagan-era U.S. Gold Commission. Portions have long been available on the Internet, but not the complete records. I suggested posting them here months ago, but the editors have not seen fit to accept any of the suggestions I have made regarding new material.

ADDENDUM: Another new book that I have not read is Brian P. Simpson, Money, Banking and the Business Cycle, in two expensive volumes. The author says, "It builds on the business cycle theory developed by Ludwig von Mises and Friedrich Hayek." Apparently the author is a proponent of 100% reserve banking.


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What We're Up Against

by George Selgin May 20th, 2014 6:36 pm

A couple weeks ago I experienced an embarrassing bout of "premature e-publication," having unknowingly made public a mere fragment of a post-in-progress, consisting of a quotation that I thought I had merely saved for future editing. That involuntary emission elicited some puzzled inquiries and speculation concerning just who the quote was from, and what its point was, for which, my humble apologies.

Here is the passage again:

Unlike the income tax, prominent lawmakers from both parties recognized the need to overhaul the laissez-faire, crazy-quilt way that money was created and interest rates determined. Private "national" banks were still in charge of issuing currency and loaning it out, in blithe disregard of the panics that resulted every few years--the latest in 1907--from such unpredictability. Everyone familiar with the problem favored some kind of regulated coordination among banks.

The words are, in fact, not Paul Krugman's (as one reader speculated). Nor are they from any economist. They are from Michael Kazin's book, A Godly Hero: The Life of William Jennings Bryan, which I'd decided to read in order to gain a better understanding of the man who played an important (if overlooked) part in shaping the modern U.S. currency system.

To be honest, even a few initial dips into Kazin's book where enough to persuade me that his was not a work that I was likely to gallop my way through with bells on. For one thing, in discussing the Scopes trial Kazin dismisses Mencken as an anti-semite, which is, to employ a Menckenesque term (and no matter what Charles Fecher says), a calumny, and a threadbare one at that. For another, he considers the fact that Bryan anticipated much of FDR's New Deal a reason for us to revise our opinion of the man upward.

So Kazin is no economist--or at least isn't enough of one to seriously reckon with the predictable consequences, for an economy faced with mass unemployment, of policies aimed at boosting prices by curtailing output. But he is a professional historian, with a teaching post a Georgetown U., who as such might be expected to do a little homework before committing to print a statement as misleading as the one I've quoted above--not to mention one brandishing such a doozy of a misplaced modifier.

Kazin, it seems, believes that panics were somehow caused by private bankers issuing currency, as if the problem had been a surfeit of that nasty private paper. In contrast every economist or economic historian worth his weight in leftover Chautauqua tickets, whether he be current or of the late 19th century, knows or knew that the problem back then was one of currency shortages, where the shortages, far from having been the bankers' fault, were a result of government regulations dating from the Civil War. Those regulations tied the stock of national bank notes to that of outstanding U.S. government bonds, the supply of which steadily declined as the century wore on, while making it it unprofitable for state banks to issue any notes at all. In Canada currency also consisted of the notes of private banks. But because the Canadian government imposed no comparable limits on its banks' ability to issue notes, Canada was spared both currency shortages and associated panics.

U.S. reformers naturally tried at first to get rid of the regulations that were the true cause (or at least one of them) of U.S. financial crises. So it's something of a kicker to realize that no man did more to oppose such reforms, "in blithe disregard of the panics that resulted every few years," than Mr. Kazin's godly hero.


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Let's not ban private money

by Kevin Dowd May 10th, 2014 10:45 pm

[originally posted at the Institute for Economic Affairs on 6 May 2014]

In a recent Financial Times article Martin Wolf announced his conversion to the view that private banks should be stripped of their ability to create money. The proposal to end private money is an old idea that periodically resurfaces in the history of economic thought, typically during crises of confidence in mainstream economic thinking when the conventional wisdom becomes discredited. An early example was the early 19th century Currency School; they succeeded in implementing it in the form of the Bank Chart Act of 1844, which imposed a 100 per cent marginal reserve requirement on the note issue and effectively gave the Bank of England a monopoly of the note supply. Later versions included the Chicago Plan advocated by Irving Fisher and Henry Simons in the 1930s; and it has surfaced repeatedly in the recent financial crisis. These more modern versions boil down to monopolising the issue of bank deposits through a 100 per cent reserve requirement.

Its proponents make extraordinary claims for it: it would slash public debt, stabilise the financial system, make the banking system run-proof and make it much easier for the government to achieve price stability. If these claims seem too good to be true, it is because they are.

In essence, this proposal is just another instance of what Ronald Coase once derided as ‘blackboard economics’ – a scheme that works well on the blackboard, but does not actually work in the real world because the economy never works the way its proponents imagine it to.

The Bank Charter Act is a perfect example. The note issue restrictions of the Act were supposed to ensure banking stability based on the premise that the underlying cause of instability was an unstable private note supply. However, it soon became apparent these restrictions created additional instability of their own, as they suppressed the note issue elasticity that previously worked to calm markets. In subsequent years – 1847, 1857 and 1866 – crises erupted that were only resolved when these note issue restrictions were temporarily suspended. The Bank Charter Act was, thus, a failure.

A second problem with the proposal to prohibit private money is that it would seriously impact the credit system because it would entail a massive switch in bank assets from private lending to government securities. Bank lending to the private sector would go to zero and banks would then exist primarily to finance government. Mr. Wolf acknowledges the issue, but almost casually dismisses it on the grounds that ‘we’ could find new (non-bank) channels to finance investment, as if the problem were easily resolved. These new credit channels would take time to emerge, however, and in the meantime the provision of credit would be to a large extent stopped in its tracks. This amounts to hitting our already fragile credit system with a sledgehammer and would probably be enough to push the economy into a depression.

But perhaps the biggest problem with any proposals to prohibit private money is not practical but intellectual: they are based on a mistaken view of the causes of economic and financial instability. Major fluctuations are not caused by volatile behaviour on the part of the private sector, but by government or central bank interventions that have destabilised the economy again and again. The Currency School is a case in point; it overlooked the point that the main causes of instability were the erratic policies of the Bank of England and the restrictions under which other banks were forced to operate. As a result, they applied the wrong medicine which then didn’t work.

More recent government interventions have created further instability: the botched policies of the Federal Reserve were the key factors behind the length and severity of the Great Depression; deposit insurance and the lender of last resort have created major incentives for banks to take excessive risks; and erratic monetary policies have greatly destabilised the macroeconomy over much of the last century. As Milton Friedman observed back in 1960:

The failure of government to provide a stable monetary framework has…been a major if not the major factor accounting for our really severe inflations and depressions. Perhaps the most remarkable feature of the record is the adaptability and flexibility that the private sector has so frequently shown under such extreme provocation.

So let’s challenge the conventional wisdom by all means, but proposals to prohibit private money are based on a false diagnosis and go in the wrong direction. The problem is not the instability created by private money, but rather the instability created by government intervention into the monetary system. Government money is not the solution; it is the problem.


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A neglected anniversary

by Kurt Schuler May 10th, 2014 9:30 pm

Max Weber was born 150 years ago on April 21. I saw no note of it on any of the blogs I follow written by economists of the Austrian School. Besides being the author of the most important book in sociology of the 20th century, Weber has some indirect relevance to free banking because he recognized that the key question for the practicability of a socialist economy is whether it can calculate efficiently (Economy and Society, part I, chapter 2, section 12, "Calculations in Kind"). The key theoretical addition to arguments for free banking over the last generation is a form of Ludwig von Mises's socialist calculation argument, which Weber slightly preceded and which he acknowledged in a note added while "Calculations in Kind" was in press.

In the same book and chapter, section 6, "Media of Exchange, Means of Payment, Money," Weber remarks, "The formulation of monetary theory, which has been most acceptable to the author, is that of von Mises." Finally, he observes in passing near the start of section 32, "The Monetary System of the Modern State and the Different Kinds of Money: Currency Money," and near the start of section 34, "Note Money," that issuing coins or notes need not be a monopoly.


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Blame the Fed for Reagan's Spending

by Bradley Jansen April 24th, 2014 5:11 pm

A nice debate has started brewing about the records of Presidents Jimmy Carter versus Ronald Reagan on spending--thanks to US Sen. Rand Paul who again seems to be setting the terms of the debate.

Mother Jones has published a video of Rand taking issue of spending rising faster under Reagan that it did under Carter.

MSNBC has publicized the video through an interesting story here saying, in part:

It’s worth emphasizing, in case details like these make a difference, that Paul’s criticism of Reagan’s fiscal record happened to be accurate. The budget deficits were smaller under Carter than Reagan. Federal spending grew slower under Carter than Reagan, too.
But to put it mildly, Republicans don’t want to hear any of this, and they tend to be thoroughly unhappy when anyone compares Reagan unfavorably to Carter, even when the analysis is true.
before adding:
After Corn’s piece ran, Paul’s office issued a statement to Mother Jones, noting, “I have always been and continue to be a great supporter of Ronald Reagan’s tax cuts and the millions of jobs they created.”
Reason has now got into the act with a story here.  They basically confirm that Rand's facts are right before concluding, "The short version: Reagan spent like a drunken sailor and skipped out on the bill."
They even include a handy chart from Veronique de Rugy at Mercatus from here report here
Reason sums up Veronique de Rugy's (in full disclosure, she is part of the Board of the think tank that runs this blog) numbers:
As de Rugy does the math, Carter increased real spending 17 percent over the last budget of his predecessor, Gerald Ford. Over two terms, Reagan increased spending by 22 percent over Carter's final budget. On an annualized basis, then, Carter grew spending by 4.25 precent a year, while Reagan grew it by 2.75 percent. However, when expressed as a percentage of GDP, spending under Carter averaged 20.6 percent per year while Reagan averaged 21.6 percent. Spending typically really gears up in a second-term president's final years, so it's plausible to theorize that had Carter managed to stick around for eight years, he might have equaled or surpassed what the real-world Reagan managed.

For those still reading along, thanks, and you might be asking, what if anything does this have to do with free banking?  Well, I would like to posit that it is at least tangentially related in that from what I remember from the early days of the Reagan Administration, he cut a deal with Congress  on spending that would have had nominal growth but real cuts based on then projected inflation.  The blame then goes to Federal Reserve Chairman Volcker for slaying the inflation dragon much faster than anticipated so that the projected real spending cuts became real spending increases.

The St. Louis Fed published a paper by Keith W. Carlson in January/February 1989 entitled "Federal Budget Trends and the 1981 Reagan Economic Plan" (pdf) explaining that "prices were generally increasing at double digit rates."  The paper goes on to illuminate my point:

The 1981 administration forecast for inflation for the 1980—86 period was a 7.1 per-cent annual rate; the actual inflation rate during this period was 5.1 percent.

So, in conclusion, yes, Rand Paul is right to raise spending as an important economic issue and take sacred cows out for fair examination--but let's not forget that the Federal Reserve deserves its share of blame both for confusing economic planners as well as monetizing budget deficits.


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Is it a currency board or a central bank? (guest post by Mike Sproul)

by Kurt Schuler April 21st, 2014 9:21 pm

(Mike Sproul responds to this post, part of a back and forth we have been having. Readers will pardon my inexpert formatting.)

A currency board gives a convenient way to explain the backing theory of money. In line (1) of Table 1, a currency board receives $100 of Federal Reserve Notes (FRN’s) on deposit, and it issues 100 of its own newly-printed paper pesos in exchange. By its nature, a currency board stands ready to redeem the pesos it has issued for the dollars it has on deposit, just as it stands ready to create and issue more paper pesos (line (2)) to anyone who deposits more dollars. It is clear from the table that whether there are 100 pesos backed by $100, or 300 pesos backed by $300, 1 peso will always be worth $1. This is an essential point of the backing theory: As we triple the quantity of pesos, we also triple the assets backing those pesos, so the peso holds its value as the quantity of pesos rises and falls. The quantity theory of money would imply that an increase in the quantity of pesos would reduce the value of the peso, because there are more pesos chasing the same amount of goods. But the quantity theory does not apply to this case, since the currency board is always able to maintain convertibility at the rate of 1 peso=$1. This idealized currency board thus gives the backing theory a foot in the door. Even someone who thinks that the quantity theory is correct for modern government-issued paper money must admit that the backing theory is correct in the case of a currency board.

Table 1

            ASSETS…………………………………..LIABILITIES

1)   $100 FRN’s………………………………..100 paper pesos

2) +$200 FRN’s……………………………...+200 paper pesos

The obvious problem of the currency board in Table 1 is that it earns no interest, and thus cannot pay its operating costs. This problem is solved in line (3) of Table 2, where the currency board prints 300 new pesos and uses them to buy a $300, 1-year US government bond. (Table 2 duplicates Table 1, except for line (3).)

Table 2

            ASSETS…………………………………..LIABILITIES

1)   $100 FRN’s………………………………..100 paper pesos

2) +$200 FRN’s……………………………...+200 paper pesos

3) +$300 bond……………………………….+300 paper pesos

With the purchase of such a bond, many of us would no longer call this institution a currency board. Currency boards are not supposed to make loans, but the purchase of a US government bond is a loan to the US government. Also, currency boards are supposed to offer immediate convertibility of pesos into US dollars. But if customers wanted to redeem all 600 of the pesos held by the public, they would have to wait for the bond either to mature, or to be sold for paper dollars. But perhaps this definition of a currency board is too literal. Currency boards often hold bonds, and they suspend convertibility every night and every weekend, and we still call them currency boards. So someone might still call our institution a currency board, even though it now looks more like a bank.

The purchase of the $300 bond doubled the quantity of paper pesos from 300 to 600, but it also doubled the currency board’s assets from $300 to $600, so the currency board is still able to maintain convertibility at 1 peso=$1. The backing theory still applies, and the quantity theory does not.

Table 3

             ASSETS…………………………………..LIABILITIES

1)   $100 FRN’s………………………………..100 paper pesos

2) +$200 FRN’s……………………………...+200 paper pesos

3) +$300 bond……………………………….+300 paper pesos

4) +600 peso loan……………………………+600 paper pesos

In Table 3, our bank/currency board lends 600 newly-issued paper pesos to a local miller, who intends to buy wheat that he will grind into flour and sell within 30 days, at which point he will repay his loan with interest. If he fails to repay, then 600 pesos worth of his property (plus interest) will be taken from him in court.

With the loan in line 4, nearly everyone would stop calling this institution a currency board and start calling it a bank. It is backing its pesos with a loan, and the loan itself is payable in pesos, rather than dollars. But the backing theory is still just as true of this bank, and the quantity theory just as false, as ever. Even though some of the bank’s assets are now denominated in pesos instead of dollars, and even though the bank has once again doubled the quantity of pesos, the bank still has enough assets to maintain convertibility at $1=1 peso. Even if all 1200 of the pesos issued by this bank were returned to the bank at once by customers demanding payment in dollars, the banker could satisfy his customers with the following steps:

1. Delay redemption of 600 pesos for 30 days until the 600 peso loan is repaid in pesos, then retire those pesos as they are received from the borrower. This reduces the number of returning pesos from 1200 to 600, and the interest on the loan can be used to compensate customers for the 30-day delay.

2. Sell the bond for $300, and use the $300 to buy back another 300 returning pesos.

3. Use the remaining $300 of FRN’s to buy back the last 300 returning pesos.

Let’s take stock of where we are. We all agree that the backing theory is true of a currency board. We have found that the backing theory remains true if that currency board buys bonds and makes loans, even peso-denominated loans. In short, the backing theory remains true as the currency board is transformed into a bank.

Now consider one last change to our bank/currency board: Let it suspend dollar-convertibility. With the peso now floating against the dollar, it might seem that the backing theory has finally been made irrelevant. But suspension of dollar-convertibility is nothing new to this bank. We have already seen that convertibility can be suspended for a weekend or for thirty days, and as long as the bank’s assets remain untouched inside the bank, the peso holds its value at $1=1 peso. Also, we must remember that the peso was initially redeemable at the bank for either dollars, bonds, or loan repayments. The bank has suspended only dollar convertibility, but bond convertibility and loan convertibility remain in force. If the public wanted to return 900 pesos to the bank, the bank could buy back all 900 pesos in exchange for its bond ($300) and its loan (600 pesos), without ever touching its dollar reserves. Dollar convertibility would only matter after the bank had paid out all its non-dollar assets.

With the suspension of dollar convertibility, our currency board now operates like a modern central bank. It never trades its pesos directly for dollars, but it nevertheless uses its bonds and loans to either issue new pesos when the public needs more pesos, or to soak them up when pesos are excessive. The central bank’s assets are crucial to the process, since a bank without assets would have nothing with which to buy back its pesos on the occasions when pesos return to the central bank. Moreover, the central bank’s balance sheet still looks exactly as it looked in Table 3: 1200 pesos are still fully backed by $600 worth of FRN’s and bonds, plus 600 pesos worth of loans. The backing theory is still fully applicable, and the quantity theory is not.

We all agree that when it comes to currency boards, the quantity theory is wrong and the backing theory is right. It’s too obvious to deny. A modern central bank is nothing but a currency board that holds bonds, makes loans, and suspends one kind of convertibility. None of these things affects the validity or relevance of the backing theory, so the backing theory is just as relevant to a central bank as it is to a currency board.


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William Jennings Bryan and the Founding of the Fed

by George Selgin April 20th, 2014 8:33 am

BryanandWilson

If William Jennings Bryan is remembered at all these days, other than as the real-life model for "Matthew Harrison Brady"--the buffoonish Bible-quoting opponent of Darwinism portrayed by Fredric March in the movie version of "Inherit the Wind"-- it is as the three-time populist presidential candidate whose campaign for a revival of bimetallism,  at the long-defunct ratio of 16:1, split the Democratic party in two, and whose "Cross of Gold" speech at the 1896 Democratic Convention gave goose-bumps both to his audience and to Wall Street's plutocrats, albeit for very different reasons.

Bryan's plea for renewed coining of silver ultimately served only to assure William McKinley's victory, and to thereby pave the way for silver's official demonetization with the passage, in 1900, of the Gold Standard Act.  But though the fact is often overlooked, Bryan's influence upon the development of the United State's currency system went far beyond his failed effort to revive bimetallism.  For Bryan also played a crucial part in the paper currency reform movement that was to lead, thanks in no small way to his influence, to the passage of the Federal Reserve Act.

To appreciate Bryan's role, one must recall the circumstances that lead, during the last decades of the 19th century, to widespread pleas for the reform of the existing U.S. currency arrangement.   During the Civil War the Union, seeking to replenish its depleted coffers, passed the National Banking Acts.  Those acts provided for the establishment of federally (as opposed to state) chartered banks, subject to the requirement that any notes issued by the new banks be fully, or (at $110 nominal backing for every $100 of notes outstanding) more than fully, secured by U.S. government bonds.  

When the number of applications for national bank charters (and associated bond sales) proved disappointing, chiefly because state banks were not tempted to convert to them, the authorities responded by subjecting outstanding state bank notes to a 10% tax.  The prohibitive tax forced most state banks to either secure federal charters or go out of business altogether, with only a relatively small number managing to survive despite no longer being able to issue their own currency.  Thus by the war's end, or not long thereafter (for the implementation of the 10% tax was eventually delayed until August 1866), national banks had become the country's only suppliers of banknotes, which, together with U.S. Treasury notes ("greenbacks") also authorized during the war, made up the total stock of United States paper currency.

Because the stock of greenbacks was itself legislatively fixed, with the intention of eventually withdrawing them altogether, national banknotes were the only component of the paper currency stock that might conceivably expand, once a ceiling on their quantity was lifted in 1875, to accommodate either temporary or permanent growth in the demand for currency.  However, that capacity was undermined by the bond-security provision, which linked the total potential stock of national banknotes to the extent of the federal governments' indebtedness, and, particularly, to the outstanding quantity of those particular government bonds that had been deemed eligible for securing such notes.   Because the Treasury enjoyed surpluses for most of the years between 1879 (when gold payments were resumed) and 1893, and took advantage of them to reduce the federal debt, national banks, rather than finding it profitable to supply more currency as the nation grew, supplied less.   Total national banknote circulation, which stood at over $300 million around 1880, had fallen to less than half that amount a decade later. 

What's more, because acquiring and holding the necessary securities, with their increasingly high market prices and correspondingly low yields, was so costly, national banks were not at all inclined to acquire them just for the sake of providing for temporary spikes in the demand for currency, such as occurred every "crop moving" season.  Consequently every autumn witnessed some tightening in the money market, as farmers came to withdraw currency from rural banks, and those banks were compelled, by the high cost of bond collateral, to draw instead on their cash reserves.   Because national banking laws allowed country banks to reckon as part of their legal reserves deposits lodged with "reserve city" correspondents, while those bankers were  in turn allowed to treat their own correspondent balances in New York (the "central reserve city") as cash, Wall Street tended to bear the brunt of this tightening, which on several occasions, and most notoriously in 1893 and 1907, manifested itself in full-fledged financial panics.

The troubles stemming from our "inelastic" currency arrangements had a straightforward solution.  That solution was not, as so many monetary economists today assume (knowing as they do the solution that was actually settled upon, but lacking understanding of the  roots of the problem), a central bank.  It was simply to free national banks, and perhaps state banks as well, from the Civil-War era shackles that, owing to long-obsolete fiscal considerations, were preventing them from supplying notes on the same terms as those governing their ability to create demand deposits.   Once allowed to back their notes with their general assets, national banks could swap notes for deposits, either permanently or temporarily, without limit, thereby conserving both their own cash reserves and those of their city correspondents.   State banks, once freed from the obnoxious 10% tax, might do likewise.   Reform, in other words, was a simple matter of leaving bankers equally free to supply customers with either paper or ledger-entry promises, according to the customers' needs.

That that is precisely what the banks would have done, had they been permitted, and that it could have worked, were far from being untested conjectures.  For proof one had only to look north.  For Canada's currency exhibited precisely the sort of elasticity that it's U.S. counterpart lacked, growing steadily while the stock of national bank notes shrank, and rising and falling with the coming and going of the harvest season.   How come?  Central banking had nothing to do with it.    Instead, Canada's paper currency stock, like the U.S. stock, consisted mainly of commercial banknotes.  The key difference was that Canadian banks, unlike the national banks, could issue notes based on  assets of their own choosing.

Canada's system differed as well in other crucial respects, though ones that did not bear so directly upon it's currency's elasticity.  Chief among these was the fact that Canadian banks were able to establish nationwide branch networks, and the fact that entry into the industry was very strictly limited.  Canadian banks therefore tended to be much larger, much more diversified, and much less prone to fail than their U.S. counterparts.  An important, though often overlooked, connection exists between banks' freedom  to issue notes and their ability to establish branch networks, in that the cost of keeping additional cash reserves is among the more important costs connected to the establishment of branches.  To the extent that banks are free to issue their own notes, the need for cash reserves, whether at branches or at the home office, is greatly reduced.  Consequently, the fact that Canada's banks enjoyed a relatively high degree of freedom of note issue meant that they were also better able to exploit gains from branching.  Well developed branch networks, in turn, indirectly contributed to the elasticity of Canada's currency stock, by allowing for local clearings that substantially reduced the cost of mopping-up surplus notes.

That numerous attempts should have been made to reshape the U.S. system along Canadian lines, especially by allowing national (and perhaps also state) banks to issue "asset currency," but also by allowing for unlimited branching, shouldn't be surprising.  What is (or ought to be) surprising is the fact that none of these eminently sensible plans succeeded.  Instead, every one--including the Baltimore, Indianapolis Monetary Commission, Gage, Carlisle, and Fowler plans--was either voted down by Congress, or scuttled in committee.

I had long supposed that opposition to unit banking, from "Main Street" unit banks naturally, but also from "Wall Street" banks that profited from the correspondent business that unit banking brought, was responsible for the failure of these attempts.  But that explanation isn't entirely satisfactory, because at least some asset currency plans didn't call for branch banking.  Something else was to blame for the utter failure of the asset currency movement.  And that something else turns out to have been...William Jennings Bryan.  For if Bryan was a tireless champion of silver, he was no less unremitting in his violent opposition to any sort of bank-issued currency, and to asset currency especially.

As a Democratic congressman (1891-95), Bryan fought not only against opposition measures calling either for asset currency or for a repeal of the 10% tax on state bank notes, but also against those sponsored by the Cleveland administration itself. So far as he was concerned, state banking was just another name for "wildcat" banking; and the Constitution's clause declaring that "No state shall...emit bills of credit" meant that allowing banks of any sort to issue notes was tantamount to surrendering a sovereign power of Congress to private corporations.(1) When, in the wake of Panic of 1893, Cleveland again called for a repeal of 10% tax, Bryan

delivered an impassioned speech in which he blamed the "crime of demonetization" [of silver] for the deflation of agricultural prices following 1873 and asserted that the federal government alone should issue paper money.  He would make all government money legal tender and prohibit, as the New Deal did, the writing of contracts calling for payment in any particular kind of money.  Furthermore, he would retire national bank notes in favor of government money.(2)

Though beaten in the 1896 presidential election, and again in his 1900 bid, Bryan retained control of the progressive minority within the Democratic party, which he employed skillfully and effectively in "waging incessant war against asset currency"(3), especially by putting paid to attempts to include any sort of currency reform allowing for such currency in the Democratic platform. "If you said anything against Bryan," a representative of long standing recalled many years later, "you got knocked over, that is all."(3)

The Panic of 1907, far from causing Bryan to modify his blanket opposition to any relaxation of existing currency laws, only made his opposition to asset currency more resolute than ever, by convincing him that bankers would stoop to anything to retain control over the nation's money. Replying, in the midst of the panic, to "editorials in the city dailies, demanding an asset currency," Bryan claimed that "The big financiers have either brought on the present stringency to compel the government to authorize an asset currency or they have promptly taken advantage of the panic to urge the scheme which they have had in mind for years."(4) Democrats, Bryan continued, "are duty bound to...oppose asset currency in whatever form it may appear" as "a part of the plutocracy's plan to increase its hold upon the government":

The democrats should be on their guard and resist this concerted demand for an asset currency.  It would simply increase Wall Street's control over the nation's finances, and that control is tyrannical enough now.  Such elasticity as is necessary should be controlled by the government and not by the banks.(5)

As if not content to assail a good idea using bad arguments, Bryan went on to endorse a genuinely rotten alternative: nationwide deposit insurance:

What we need just now is not an emergency currency but greater security for depositors. ...All bank depositors should be made to feel secure, and they could be made to feel secure by a guarantee fund raised by a small tax on deposits. What depositors feel sure of their money they will not care to withdraw it.(6)

During the 1908 presidential campaign, his third and last bid for the presidency, Bryan, in deference to the party's divided opinion on the subject, downplayed the currency question, but lost to Taft anyway. Four years later, however, he was instrumental in securing Wilson's nomination, which he favored in part because Wilson seemed to echo his own beliefs in declaring, in a 1911 speech, that "The greatest monopoly is the money monopoly." When further examined by Bryan, Wilson passed with flying colors by again stating that he would oppose any currency plan "which concentrates control in the hands of the banks"(7). Wilson was thus able to secure the democratic nomination, for which he thanked Bryan by making him his Secretary of State.

By the time of Wilson's election, former advocates of asset currency had for some years given up any hope of achieving their preferred reforms, and had instead turned their attention to the alternative of establishing a "central reserve" bank, charged with supplying currency to supplement, and perhaps replace, the limited quantities forthcoming from the national banks. But here again they encountered opposition from progressives, including Bryan, who was no less opposed to reforms that smacked of European-style (or, for that matter, Bank of the United States-style) central banking than he had been to asset currency itself. The Aldrich plan, ostensibly the fruit of the National Monetary Commission's extensive deliberations, but really a scheme secretly cobbled together by Aldrich and his banker friends at Jekyll Island, was (according to Paolo Coletta) "particularly anathema to Bryan...because it called for a single, privately controlled central bank located in New York."(8) Bryan also believed--correctly--that "big financiers" were behind Aldrich's "scheme."(9)

Though he also wished to steer clear of a European-type central bank Wilson thought the Aldrich plan "about sixty or seventy per cent correct," and so had Carter Glass come up with an alternative that differed chiefly in proposing numerous regional reserve banks governed by a Federal Reserve Board. But because the proposed Board was mainly to consist of bankers, and so left them in charge of the nation's currency, Glass's plan also dissatisfied Bryan, who "was exceedingly disturbed at those provisions of the [bill] contemplating currency in the form of bank notes rather than greenbacks" (10), and who, as the most prominent member of Wilson's cabinet, was capable of killing Glass's bill, just as he'd killed previous asset currency measures. When Robert Owen, an old associate who was now chairman of Senate Banking and Currency Committee, drafted an alternative calling instead for new Treasury issues to replace existing national banknotes, Bryan naturally preferred it, placing the Glass plan, which was already encountering stiff opposition from bankers, in still greater jeopardy.

Yet Wilson managed, by means of some very clever politicking, to rescue Glass's Federal Reserve plan. To scare the bankers into supporting it he had William McAdoo, his Treasury Secretary, offer (to Glass's considerable dismay) a "compromise" that would have replaced banknotes, not with redeemable Treasury notes (as contemplated by Owen's plan), but with legal-tender notes resembling the Civil War-era greenbacks.(11) To win Bryan over, he had Glass revise his bill by making Federal Reserve Notes obligations "of the United States" as well as of the Federal Reserve banks themselves, and by excluding banker representation from the Federal Reserve Board.(12) When Glass's bill, having made it through the House Banking Committee, was attacked by Bryanite Democrats at the party caucus, Glass stunned and silenced them by brandishing Bryan's letter calling for his supporters "to stand by the president and assist him in securing the passage of this bill at the earliest possible moment" (13). Thanks to Bryan's support, the Federal Reserve Act became law just two days shy of Christmas, 1913.

And so it happened that, through his unrelenting efforts over the course of more than two decades, William Jennings Bryan, the most stalwart enemy of both private currency and currency monopoly since Andrew Jackson, helped to create a currency monopoly far more powerful than any that Jackson could ever have envisaged, and far more capable of gratifying Wall Street, at the expense of the rest of the nation, than Wall Street alone, left perfectly free from government controls, could ever have devised.
___________________________

(1) Paolo E. Coletta, "William Jennings Bryan and Currency and Banking Reform," Nebraska History 45 (1964), p. 33.

(2) Ibid., p. 35.

(3) Gerald D. Dunne, A Christmas Present for the President, Federal Reserve Bank of St. Louis, p. 9.

(4) William Jennings Bryan, "The Asset Currency Scheme," The Commoner 7 (43) (November 8, 1907).

(5) Ibid.

(6) Ibid. Besides overlooking the moral hazard problem, Bryan's argument neglects the fact, crucial to a proper appreciation of the advantage of asset currency, that bank customers often wish to convert deposits into currency for reasons, like paying itinerant workers, having nothing to do with doubts concerning the safety of bank deposits.

(7) Colette, p. 41

(8) Ibid., p. 42.

(9) James Neal Primm, A Foregone Conclusion: The Founding of the Federal Reserve Bank of St. Louis, St. Louis: Federal Reserve Bank of St. Louis, 2001.

(10) Dunne, p. 11.

(11) Ibid., p. 13.

(12) Glass went along with this plan only owing to his understanding, the correctness of which Wilson readily affirmed, that the supposed obligation "would be a mere pretense," the government's obligation being "so remote that that it could never be discerned" (Colette, pp. 48-9).

(13) Dunne, p. 19.


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