Fools’ Gold

 

When the slaves revolt, they will seek the blood of their masters.

Guest post by Robert Gore at Straight Line Logic

In 2013, a century after the establishment of the Federal Reserve, I published The Golden Pinnacle. The novel’s hero is Daniel Durand, a Wall Street banker. Chapter 27, “Fools’ Gold,” features Daniel’s testimony in 1913 before a House of Representatives subcommittee against legislation under consideration that would establish the Federal Reserve. Eleanor is Daniel’s wife and Tom and Alexander are two of his four sons. As the current banking crisis unfolds, I won’t have much to say that will add in any meaningful way to what I said in “Fools’ Gold”. Why repeat myself? Perhaps I’ll just keep linking back to this post. Please share in whole or in part with attribution and a link back to this post.

From “Fools’ Gold”

Daniel sat at a table in a committee hearing room of the House of Representatives. The drafts crisscrossing the room carried the winter cold of February. There were few spectators in the gallery. Daniel glanced at Eleanor, who sat with Tom and Alexander, but she was staring in a different direction. Although she had wished him well, she had seemed preoccupied when they met briefly in the hall outside the hearing room.

Members of the subcommittee of the House Committee on Banking and Currency strolled to their seats, signs denoting the representative, at an elevated, semicircular panel at the front of the room. They chatted with each other. Nine representatives sat down. The chair for Representative Bulkley of Ohio remained empty. The chairman of the subcommittee, Representative Carter Glass, from Virginia, banged his gavel.

“The hearing in consideration of House Bill 7837, for the establishment of a federal reserve bank and the furnishing of an elastic currency, shall now come to order. The subcommittee will hear the testimony of Mr. Daniel Durand, from the firm of Durand & Woodbury, of New York.” Chairman Glass’s accent had an unmistakable Virginia lilt that reminded Daniel of Aldus Kincaid, his attorney for the court of inquiry. A dapper gentleman in his mid-fifties, Glass had prominent ears and a nose that filled a larger proportion of his face than the average nose filled of the average face.

“Thank you, Mr. Chairman, and thank you, members of the committee,” Daniel said. “This legislation is still in its early stages and the details of the reserve system are the subjects of dispute. However, before everyone is enmeshed in them, it’s time to consider not just the purported benefits but also the real dangers of central banking and government-created money, or an elastic currency, if you will, and to ask if this supposed innovation is in the best interests of our country.” He glanced at his notes.

“A persistent misnomer is the term ‘bank deposit,’ which is not a deposit at all. If I take an item to a warehouse and pay a fee to deposit it for safekeeping, when I exercise my contractual rights and claim it, the owner of the warehouse must give it back to me. The owner can’t lend it out, use it to secure a loan, or give it to another depositor to satisfy his claim. On the other hand, when I put my money in a bank, the banker can lend or invest it, use those loans and investments as collateral to borrow money, or use my funds to pay creditors or other depositors. I haven’t deposited my money in the same sense that I deposited the item at the warehouse.

“My deposit is actually a loan and I’m an unsecured creditor of the bank. Much of the instability of the present system stems from a fiction. The respectable bank is housed in a neoclassical fortress and prominently displays a sturdy vault, to convince the depositor his money is safe. In fact, almost all his money leaves the bank in search of a return higher than the interest the bank pays him. Only a small portion is held in reserve to meet depositor withdrawals, although all depositors are told they can withdraw their money on demand.

“The bank has made a promise that it can’t always keep. Business and financial cycles are as immutable as human nature. When famine follows feast and fear replaces greed, the demand for money inevitably increases. The banker faces his worst nightmare—a run on the bank. Banks with sufficient reserves or borrowing power survive. Those without them go bankrupt.”

Daniel looked up at the representatives. Only a couple appeared interested.

“When faced with the danger of these inevitable bank runs, bankers clamor for a lender of last resort, a central bank. If only the banks could take their loans and investments and pledge them as collateral for ready money from a central bank. It’s an alluring prospect—put out the fire and repay the loan when conditions improve—but where does the central bank get its money?

“Freely convertible paper money is anchored to the quantity of available gold and silver—it’s not elastic. The only elastic money is that which can be derived from thin air. That’s the key to understanding the support from both the bankers and the government for central banking. A banker doesn’t care if the money he uses to satisfy his obligation to his depositor was printed up that morning. All he cares is that he can obtain it by borrowing from the central bank against his bank’s collateral. There’s a more subtle point. When a central bank stands ready to lend in a panic, bankers can relax during more normal times. They reduce the amount of money they keep on ready reserve and lend out the new excess. They make riskier loans to increase their profits. A central bank has been touted as a means of reducing risk, but it will actually increase it.

“For the government, money from thin air is the philosopher’s stone. The alchemy of central banking is a much easier way to obtain money than either taxation, which must be approved by the voters or the legislative branch, or borrowing, which has the troublesome requirement that the money be repaid. Every dollar the central bank creates finds its way into the banking system, funding factories, mortgages, purchases of goods and services, and jobs, all of which make people more inclined to reelect their elected officials.

“This prosperity proves illusory. More money pursuing the same amount of goods and services pushes prices up, thus devaluing the money people already have. While the government realizes a short-term benefit from the new money, it comes at the expense of its citizens, who hold a depreciating currency. For politicians, the best part of money creation is that it’s a hidden tax. Most people have no idea the central bank is picking their pockets. Since debts are repaid in depreciating currency, debtors, including the government, gain at the expense of creditors.”

Daniel paused and surveyed the representatives. Most of them looked as if they wished they were somewhere else. One representative’s barely concealed contempt seemed to say: of course, you fool, that’s why we want to do it. Was it possible to hold politicians in too low an esteem?

“Historically, government money creation follows a dreary progression. A government wants more money than it’s able to borrow or take from its citizens. It first debases the money already outstanding. Precious-metal coins are alloyed with or replaced by baser metals. If paper currency is convertible into precious metal, the exchange ratio is increased. As Gresham noted in 1558, bad money drives out the good. People separate the wheat from the chaff—they use the paper currency and hoard the coins. The government then enacts a legal tender law, forcing people to accept the paper currency at a government-mandated value. To keep its precious metal, the government curtails and eventually prohibits conversion of the paper money.

“The government creates money until its value falls to its cost of production, close to zero. Like the opium addict who must continuously increase the amount he uses to achieve the same delirium, the government must produce an ever-increasing amount of money to achieve the same illusory prosperity. Since the store of value has become elastically indeterminate, production declines while speculation increases. Since debtors win and creditors lose, savings vanish and debt increases. Eventually this house of cards collapses and illusory prosperity is replaced by very real depression, bankruptcy, and ruin.

“Washington Irving captured this progression in his book The Great Mississippi Bubble, written in 1830 about events in 1720. He noted that ‘every now and then the world is visited by one of those delusive seasons when the “credit system,” as it is called, expands to full luxuriance….the broad way to certain and sudden wealth lies plain and open.’ The inevitable result? ‘A panic succeeds, and the whole superstructure built upon credit and reared by speculation crumbles to the ground, leaving scarce a wreck behind.’” Daniel looked up from his notes. “Gentlemen, I believe that you know where this legislation will lead. Adam Smith said, ‘There is a great deal of ruin in a nation.’ After the greatest explosion of industrial and technological progress in history, there is much ruin in our nation. It will come several generations in the future, when everyone here is safely dead and gone, but if we start down this path our wealth will make our ruin no less inevitable. Is that the legacy you want? I implore you to halt this rush to central banking and government-created money, not out of a fear of the unknown, but from a clear-eyed appraisal of a known and unbroken record of failure. Thank you.”

“Thank you, Mr. Durand,” murmured Chairman Glass. “Allow us a moment to get our notes in order and we’ll open the floor to questions from the members.”

Several of the members stood to stretch their legs while legislative aides refreshed coffee cups and water glasses. Daniel glanced at Eleanor and she smiled, but there was something wrong with her smile. He’d find out what it was soon enough, for now he had to put it out of his mind.

The subcommittee members settled into their chairs. Chairman Glass cleared his throat. “Mr. Durand, how would you address the manifest problems of the current system, especially that of bank runs, without a central bank?” Glass was a strong supporter of the legislation.

“I’d start by calling a deposit what it is—an unsecured loan to a speculative enterprise known as a bank, which the depositor, or more correctly the creditor, may or may not be able to withdraw when he desires. Contractual recognition of that reality would allow the bank to curtail or stop withdrawals during a panic without going out of business. It would put a brake on the panic. Solvent banks would have time to call in loans and investments and arrange financing. Insolvent ones would fail and incompetent bankers would be put out of business. Bankers would have to pay for this privilege of limiting withdrawals with a higher rate of interest on deposits. Safety-minded depositors would gravitate towards banks that maintained a higher percentage of reserves.”

“Wouldn’t that have the effect of constricting the general credit?”

“It would. Banks would be paying depositors more and maintaining higher reserves; they’d have less to lend and invest. Lending and investing would be for productive activities that produce a return that liquidates the loan. With fewer loans and investments of better quality outstanding, the system as a whole would be far less prone to instability. Overall, credit would expand in line with the productive capacity of the economy. As Mr. Irving noted, expansion beyond that capacity leads to ruin—you can’t consume more than you produce.”

“Mr. Glass, may I?” asked Representative Korbly, from Indiana. Glass nodded.

“Mr. Durand, what about the depositor who wants absolute safety and the assurance he’ll always have access to his money? Your way would leave him out in the cold.”

“Mr. Korbly, there’s no such thing as absolute safety, under either the current system or the proposed reserve system. The closest a bank customer could get to absolute safety would be a fortress bank that takes his money and locks it in a strong vault. Reject this legislation and I’ll capitalize such a bank with a million dollars. I’ll put a vault with a six-inch steel door in a building with walls the thickness of a castle and I’ll guarantee depositors—who will be depositors, not creditors—access to their money in person during banking hours or by drafts drawn on their account. Nothing is free, of course; they’ll have to pay for safety. I’ll charge the fees necessary for my bank to turn a profit, since I won’t be lending or investing depositors’ funds.”

“Your bank would be a rather boring business.”

“That kind of banking should be boring. People with money who want more risk can speculate in our stock and bond markets, or they can invest their money with intermediaries such as Durand & Woodbury, which they understand to be a speculative enterprise.”

“Why couldn’t you open your fortress bank if we passed this legislation?”

“Because I would be in competition with the U.S. government. When the government becomes the lender of last resort, everyone becomes less vigilant about where they leave their money. The government can print, borrow, and now, with the income tax, take money to support the banking system. Why worry about safety?”

“Excuse me, Mr. Korbly.” The speaker was Representative Taylor, from Alabama. His fleshy jowls jiggled when he talked. “Why do our nation’s strongest banks support this legislation, Mr. Durand?” he said in a thick Southern accent.

“If the only function the central bank performed was as a lender of last resort, the strong banks would fight this legislation as a prop for their weakest competitors. However, that function will allow all banks to hold less in reserve, which will allow them to lend more and make more money. An elastic money supply puts more money in the system, which leads to more lending and profits, for a while. The regulation that goes with this legislation will make it harder for new entrants into banking. Less competition means more profits. The Pujo subcommittee just concluded its investigation of the so-called money trust. Cartels and monopolies are difficult, if not impossible, to maintain without the aid of the government. This legislation enshrines a money trust—a banking cartel. That’s why the large banks support it.”

“Why do you say an elastic money supply allows more lending and profits only for ‘a while’?” said Representative Vreeland, from New York. Daniel found it curious that he ignored his assertion that the legislation would enshrine a cartel and instead seemed concerned that the new law’s profits for banks might only be temporary.

“Because dishonest money sets a country on the road to bankruptcy, and when the government goes bankrupt it takes its banking cartel with it.”

“You talk of dishonest money and debasement. You are aware that all the reserve bank assets will be backed forty percent by gold?” said Representative Talbott, from Maryland.

“I don’t believe for a moment the assurances that there is no intent to debase the currency or prohibit its exchange for gold. I heard the same thing as a soldier during the Civil War, but the government printed so many greenbacks that our thirteen-dollars-a-month pay became virtually worthless. Soldiers played poker and other games of chance, trying to attain a living ‘wage.’

“Debasement by the government is inevitable because the government benefits from it. That forty percent reserve requirement can be changed with new legislation. It will shrink until it vanishes. I draw no comfort from a promise that supports a promise the government won’t keep. Eventually, government-created money won’t be convertible into real money—gold.” Daniel took a deep breath. He had just called the representatives liars and thieves.

“Why do you speak of suspending convertibility? No such action is under consideration.”

Daniel took out a double eagle—a twenty-dollar gold piece—and a twenty-dollar bill and laid them side by side on the table before him. He held up the gleaming coin. “For centuries gold has served as a store of value and a medium of exchange. An ounce of gold bought a man’s suit in 1500, 1600, 1700, 1800, and now, in 1913. It takes real resources to find, mine, smelter, and mint gold. It’s divisible, portable, storable, assayable, indestructible, and, I might add, beautiful.” Daniel put the coin down and picked up the bill. “This is a twenty-dollar bill. It can be torn to shreds and thrown to the wind. Its cost of production is virtually nothing. It depends for its value not on any intrinsic quality, but on the willingness of people to accept it as payment and the promise of politicians not to print too many of them. That promise has been broken every time it’s been made. Mr. Talbott, the law says they must be regarded as equivalent. I’ll offer you a choice. Which would you prefer?”

There was no answer.

“If this legislation becomes law, this piece of paper will buy less in ten years than this coin. Gold has been called an anachronistic relic, but you can’t fool all the people all the time. Depreciating paper will be exchanged for gold. The government will have to mandate acceptance of its counterfeit money and the number of dollars necessary for conversion to a stated amount of real money will steadily increase. Eventually convertibility will be suspended so the government doesn’t lose all its gold.”

“Mr. Durand, you’re a wealthy Wall Street banker.” The speaker was Representative Moore, from Texas. “Your point of view represents a certain segment of the moneyed class. A reserve bank and a less astringent currency will promote economic stability, which will help farmers and wage earners, the people who have not shared your good fortune.”

“On one point I cannot argue, Mr. Moore. Depreciation devalues debt, so if a farmer or wage earner is in debt, he can pay it off with devalued money. If, however, he’s a saver, his savings are devalued. That’s one of many pernicious results of elastic money—it encourages debt at the expense of saving. Wages will buy less every year. What the government gains from monetary debasement, the wage earner loses. Adjustments to his wage won’t keep up with money inflation. As for promoting economic stability, look at the railroads. Every line upon which the government has laid its ‘benevolent’ hand has come to ruin. You want to make it responsible for the entire economy? The Wall Street moneyed class will have a field day with elastic money and financial instability. It’s your average wage-earning American who will be hurt the most.”

“Mr. Durand,” Representative Korbly said. “I find your opposition to this progressive innovation old-fashioned and reactionary. You’d put a straightjacket on the government.”

“The Chinese invented paper money around the year 900. By the turn of the millennium they had invented inflation. There’s nothing innovative about governments debasing their currencies. They’ve been doing it for centuries with the same ruinous result. Honest recognition that a deposit is a loan and privately issued money backed by gold would be true innovations. The straightjacket you dislike is the idea of limited government, which was the Founding Fathers’ idea.”

“This is a banking issue, not some question of fundamental liberty,” Korbly said.

“Gentlemen, since the end of the Civil War, this country has approached the golden pinnacle of human liberty. Our people have enjoyed more freedom than any people have before. They’ve worked in their chosen occupations; kept what they earned in money of certain value; saved, invested, innovated, and taken risks; voluntarily exchanged the fruits of their efforts; said and wrote what they wanted, traveled where and when they wanted, worshiped the way they wanted, lived where they wanted, associated with whom they wanted, and voted for their leaders. In short, they’ve pursued their own happiness, for the most part unhindered by a government conceived to secure their liberty.

“The result has been an unprecedented explosion of knowledge, technology, enterprise, and creativity. Capitalism—the economics of free people—has lifted millions from poverty, made America rich, and been a beacon for ambitious immigrants from all over the earth. The forty-eight years since the Civil War haven’t been without their blemishes, their ups and downs, but I challenge you to find a comparable period in history when a nation has enjoyed the progress, prosperity, and peace that ours has.

“Take the path you are proposing and these last forty-eight years will far surpass the next forty-eight. You say this isn’t a question of fundamental liberty. The income tax amendment gives the government first claim on the labor of every producer in the country. This reserve bank and elastic currency mean that the value of what they’re allowed to keep will be determined by political whim, not the objective reality of the value of gold. What liberties are more fundamental than to keep what you earn, and to keep it in a store of objective value? With two strokes the government that was almost our servant will have become our master, and the golden pinnacle will recede into the mist. It’s cold, trivial comfort that you’ll leave us with some of our rights. We’ll be free to complain about our slavery and to elect the leaders who will perpetuate it. As the utopian dream dissolves into nightmare reality, those rights will be eliminated as well.”

Daniel paused and looked up at the representatives. “Allow me to give you and your successors a warning. Someday a hoodwinked, enslaved, bankrupted people will realize who is responsible for its ruin. When the slaves revolt, they will seek the blood of their masters. Thank you.”

The only sound in the room was Daniel gathering his notes. He stood and walked back to Eleanor, Tom, and Alexander, who were all staring at him, wide-eyed. They rose and walked with him out of the committee room.

In the hall, Tom said, “You were the one to stand up and say, ‘this is wrong,’ but I can’t believe there won’t be hell to pay.”

I wonder why I had to self-publish. The Golden Pinnacle is available on Amazon in both paperback and Kindle versions.