My grandson had quite a day at school.He had learned that
the economy had been suffering from things called Panics, capital P, during
the 19th century and had another big one in the early 20th century.He had
been told that responsible, public-spirited men like J. P. Morgan had
organized a central bank to prevent those Panics.He and other bankers finally
got the government to go along with their idea and pass it into law in late
1913.And wouldn’t you know it — we’ve had no more Panics since then.
He looked doubtful, though. He didn’t understand
what a central bank did, exactly. And wasn’t the Depression and the
recent Financial Crisis kind of like a Panic, only called a different
name? And if those calamities were like Panics, then why didn’t the
federal reserve prevent them?
His teacher said that this country and most countries of
the western world were on a gold standard during the days of Panics.
Economists and other people decided that the real culprit behind the turmoil
was the gold we used as money. So we got rid of gold for the stuff we
use today . . . which doesn’t come out of the ground . . . which comes from
the government but is regulated by the people in charge of the federal
reserve, which is not really part of the government, though they’re close
friends.
“Ok,” he said, “so we have gold causing us and other
countries all those Panics and we got rid of it. But we didn’t get rid
of it.” He said his teacher told the class about the vault at the
Federal Reserve Bank of New York, which houses gold for other countries.
The vault is 80 feet below street level and 50 feet below sea level. He
found that astounding. The vault is protected by armed guards, CCTV,
and electronic surveillance. And the guards are trained marksmen.
Then his teacher pulled out his tablet and read this to
the class, which my grandson read to me from his smartphone:
There are no doors into the gold vault. Entry is through a
narrow ten-foot passageway cut in a delicately balanced, nine-feet-tall,
90-ton steel cylinder that revolves vertically in a 140-ton,
steel-and-concrete frame. The vault is opened and closed by rotating the
cylinder 90 degrees. An airtight and watertight seal is achieved by lowering
the slightly tapered cylinder three-eighths of an inch into the frame, which
is similar to pushing a cork down into a bottle. The cylinder is secured in
place when two levers insert large bolts, four recessed in each side of the
frame, into the cylinder. By unlocking a series of time and combination
locks, Bank personnel can open the vault the next business day. The locks are
under "multiple control" no one individual has all the combinations
necessary to open the vault.
He found this even more astounding.“Why?” he wanted to
know, “Why all the protection for something that’s worthless?Why even keep it
around, except maybe for rings and other jewelry?”
As I started to answer he interrupted me.
“That bank stores the gold of other countries. Fort
Knox vaults the gold Americans once had. And it’s a piece of work,
too.”
He told me the depository was on an army base, and the
building that housed the vault was made of North Carolina granite. When
the government ordered Americans to turn in their gold coins they melted it
down into bars and shipped them by rail to the depository under heavy guard.
“But it’s not just gold stored there,” he said. The
place is so secure the government stored the Declaration of Independence and
the Constitution there during World War II — the original documents. It
also held four exemplified copies of the Magna Carta, which had been on
display during the 1939 World’s Fair in New York.
“And get this,” he added, again reading from his
smartphone:
During World War II and into the Cold War, until the
invention of different types of synthetic painkillers, a supply of processed
morphine and opium was kept in the Depository as a hedge against the US being
isolated from the sources of raw opium.
“What’s going on?” he wanted to know.“Drugs are bad, gold
is bad, right? They’re against the law.But we protect them like our very lives
depended on them.”
“Yeah. Why didn’t government just dump the gold into
the ocean or drop it down a volcano?
“For that matter, why did the government order people to
turn it in? If they didn’t want people using it for money, why not just
say it was no longer legal.
“I checked the Constitution during study hall. It
says no state shall coin money. It also says no state shall make
anything but gold or silver coins a tender in the payment of debts.
Since the federal government is prohibited from doing anything not explicitly
authorized by the Constitution, that would mean private mints would coin
money. Right?”
I told him I couldn’t answer his questions on the
constitution, other than to say it’s become a dead letter, meaning that men
in power have used tortured arguments to interpret it to suit their purposes
or have ignored it altogether in the name of “national security.”
I told him when “national security” is used to justify any
government action we’re either at or headed for a dictatorship. He
agreed. Then I attempted to fill in some other blanks he left.
Explaining why we went from gold to fiat paper money
A central bank, I explained, is a bank only to its member
banks, not to people like you or me. It holds its members’ deposits as
reserves on which the commercial banks can issue loans.
At the time of the Fed’s creation in 1913 gold and to some
extent silver were still legal money in the United States. Holders of
gold or silver coins could walk into stores and buy things with them, or
deposit them in banks. In some cases they could get banks to exchange
notes for coins, though that became uncommon after 1917 when commercial banks
began shipping their gold off to regional federal reserve banks where they
were added to the banks’s reserves.
People, thereby, lost the use of gold coins and became
acclimated to paper. They were confident, though, that if they really
wanted the gold the paper money promised to pay, they could get it.
That confidence crashed and burned in 1933 when FDR
ordered Americans to turn in their gold coins — or else. They were
given assurances of the necessity of the heist — which has also been called a
“gold recall,” as if the gold itself were defective. It was a national
emergency, and Americans knew the government took away their rights in a
national emergency.
Many of them recalled the social environment of World War
I where people could get arrested for reading the Bill of Rights
publicly. And during the American Civil War Lincoln suspended habeas
corpus and ordered the arrest and imprisonment of anyone challenging his
policies. Even the Constitutional Convention amounts to a violation of
rights inasmuch as the delegates created a new government rather than revise
the charter of the existing one, as they were empowered to do. I
suppose they would have said ‘national security’ required the ditching of the
old government.
When Roosevelt delivered his first inaugural address he
referred to the depression as an emergency comparable to war, thus setting up
his listeners for some drastic measures. Later, when he ordered people
to turn in their gold, he told them not to worry. The paper they would
be using was good stuff, guaranteed. Gold was preventing a recovery —
somehow — even though the classical gold standard had been ditched almost two
decades earlier. If that doesn’t make sense rest assured monetary
issues were complicated, and only the best and brightest could untangle them.
And Roosevelt had those kind advising him. Besides, one of the best and
brightest had said the gold standard was a barbarous relic, and it was
obvious prices were too low, and the only way to bring them up was to
manufacture more money. But how are you going to do that with a scarce
commodity like gold?
“In a sense, though not the right one, gold did cause the
Panics you mentioned.” I said banks had been engaging in fractional
reserve lending, where they would promise to redeem in gold coin all the
banknotes and deposits for which they were liable. But they expanded
the banknotes and deposits beyond the amount of gold they had, a form of
embezzlement, though bankers and their friends don’t see it that way.
Banks were creating multiple receipts to the same weight of gold, and those
receipts circulated as money. In that way they were inflating the money
supply. They got away with it until depositors got nervous about the
bank’s ability to pay out in gold or until some other bank attempted to clear
payments and discovered the inflating bank couldn’t do it.
The public’s discovery of an over-inflating bank led to
distrust of other banks, and soon there was chaos known as a Panic.
Bankers and most economists see nothing wrong with expanding credit beyond
the money in the vault. They consider it a sound practice that only
becomes unethical and disruptive when the banks expand too much.
Instead of ceasing the practice of fractional-reserve
lending they directed their wrath on gold. If they didn’t have to redeem
their notes in gold they could inflate to a much greater degree. Get
rid of gold, establish an institution that can provide funds during an
emergency — in other words, a central bank — and the chaos would end.
Only it didn’t. Gold acts as a brake on inflation,
and without it the monetary unit we call the dollar starts to proliferate and
lose value. With economists focused on prices instead of the money
supply they missed the inflation of the 1920s. They said inflation was
a rise in prices, and there was very little of that in the 1920s, except on
the stock market. When the Crash hit it came as a big shock — though
not to Ludwig von Mises, an economist of the Austrian school.
Did they see their mistake and rethink their
theories? No. Once again they seethed over gold’s role as true
money. President Roosevelt seized it from the public, but the
Depression continued long after that event.
Why the government protects gold to such an extent is a
mystery to me. Gold has always been a highly valued commodity, even
now when it’s not used as a general medium of exchange. So it would
make sense for the government to safe-keep it. But that only pushes the
question back further. Why is it such a highly valued commodity?
Not every government has kept it. Gordon Brown,
Britain’s Chancellor of the Exchequer, sold roughly half of the UK’s gold
reserves between 1999-2002.
“We should be free to decide what to use for money,” I
told him. “I would prefer something the supply of which can’t be
increased easily, such as gold. And banking should be subject to the
laws of the market, instead of granted privileges protecting it from the
market.”
He asked me to tell him again the name of the economist
who predicted the Crash. I was pleased to do so.
Announcement: I have new books up on Amazon:
United States Bullion Depository, Wikipedia
Sale of UK gold reserves, 1999–2002, Wikipedia
