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An Address
by
Antal E. Fekete
Professor of Money and
Banking
San Francisco School of Economics
at a Fund-Raising Dinner for the benefit of the Ficino
School
Auckland, New Zealand
October 28, 2009
The year 2009 will most likely expire without
commemorating the centenary of a most momentous event in history that figures
prominently as the main cause of the Great Financial Crisis of the century.
This event was the so-called legal tender legislation in 1909. The bank notes
of both the Banque de France and the Reichsbank of Germany were made legal tender by law,
first in France and then, a very short time later, also in Imperial Germany.
The rest of the world followed suit. In this way all roadblocks were removed
in the way of financing the coming world war through credits and monetizing
the resulting debt through the issuance of bank notes.
One unintended effect was that all efforts to avert
the war and the concomitant great bloodshed and destruction of property
through better diplomacy were short-circuited. The war parties in both
countries had won a great victory. The cause of peace suffered a decisive
defeat.
Please note that I have said “so-called legal tender legislation”
because ‘legal tender’ in this context was a vicious distortion
of the meaning of the phrase. There was nothing coercive about legal tender before
1909. Bank notes circulated as money, but their acceptance was entirely
voluntary. People had an unconditional right to exchange them for the coin of
the realm, that is, for gold coins. If the bank did not comply, then it was
in technical default and had to face the consequences.
The original meaning of legal tender simply referred
to a tolerance standard applicable to the wear and tear of gold coins. Coins
meeting the tolerance standard circulated by tale, that is, their value was
established by counting them out ― a great convenience. Others
circulated by weight: each and every coin had to be weighed ― a great
inconvenience. There was absolutely no coercion involved in this
discrimination. The Mint exchanged gold coins within the tolerance standard
by freshly struck full-bodied gold coins at no charge to bearer. The
government absorbed the loss and covered it out of the general revenue fund.
The cost was treated the same way as the cost of maintaining the
nation’s highway system in good repair. Not only was there no coercion
involved in legal tender laws; in effect a public service was provided by the
government without charging user-fees. That was the meaning of the phrase
“legal tender” prior to 1909.
Notice the underhanded change in the meaning as a result of the legal tender
laws of 1909. A public convenience was replaced by public coercion. Two
governments with the greatest war-making power in the world introduced
coercion forcing their subjects to accept and use debt as money. This was a
‘first’ in history. In particular, the governments were forcing
the military, as well as civil servants, to take paper promises as ultimate
payment for services rendered.
Of course, the use of the phrase ‘legal
tender’ in this way is an oxymoron. A promise to pay that is at the
same time an ultimate payment is not a promise. It is an
ukase. This was a reactionary step, designed to facilitate the unlimited
augmentation of monetary circulation regardless of the gold reserve. It
allowed the financing of the coming war with government credits, much of it
interest free and with no maturity date. The burden was thrown on the
shoulders of the people without their concurrence.
The measure was represented as an innocent house-keeping change. There was no
public debate on its wisdom. Nobody at the time could see the ominous
consequences. Nobody suspected bad faith on the part of the government. As a
proof of good faith gold coins were allowed to remain in circulation for
another five years. Banks paid them out routinely as before, without fuss.
There was no noticeable increase in the hoarding of gold coins by the people,
a sign that they implicitly trusted their government. When the war finally
broke out in 1914, the “guns of August” heralded the delayed
effect of the legal tender laws. All gold coins went into hiding at once.
Banks refused to meet any request for payment in gold. Members of the
legislation, including all the socialist deputies, voted all the war-credits
the government had asked for without demur.
The first author to unmask the connection between
the Legal Tender Laws of 1909 and the outbreak of the war five years later,
in 1914, was the German economist Heinrich Rittershausen
(1898-1984). He also predicted the Great Depression, and linked the coming
unprecedented wave of unemployment to legal tender, as I am going to discuss
it in more details in a minute.
We are left to second-guess history. Would the
senseless killing and destruction of property have come to an early end in
the absence of legal tender laws, just as soon as the belligerent governments
had run out of gold to finance it? Most contemporary observers had predicted
that it would have. There was no way to finance a conflict of this magnitude
out of taxes. People did not understand that legal tender was an invisible
form of tax to pay for the greatest war up to that point in history. They did
not understand the power of credit that would enable governments to expend
blood and treasure freely, without any restraint. People did not see the
Moloch behind the façade of legal tender ― the god that was
preparing to devour his own children.
*
* *
But there was also another, most
sinister consequence of the legal tender laws that was not recognized at the
time. Before 1909 world trade had been financed through real bills drawn on
London. A real bill was a short-term commercial paper payable in gold coin
upon maturity. It represented self-liquidating credit to finance the
emergence of new merchandise in the markets demanded most urgently by the
consumers. As its issue was limited by the amount of new merchandise on its
way to the market, it was non-inflationary. The credit was liquidated by the
gold coin released by the ultimate consumer of the underlying merchandise.
You can look at a real bill as credit in the process of presently
“maturing into gold coins”. As a medium of exchange, a real bill
is “the next best thing” to the gold coin. It is virtually risk
free to hold, as the underlying merchandise has a ready market waiting for
its arrival.
Clearly, real bills are incompatible with legal tender laws. It makes no
sense to suggest that you can make real bills “mature in legal tender
bank notes”. The fact is that the bank note is inferior to a real bill
in almost every way. For one thing, real bills are an earning asset. This is
due to the existence of discount applied to face value as the real bill is
bought and sold before maturity. Real bills are most liquid: only the gold
coin has greater liquidity. They are the best earning asset a commercial bank
can have.
But what makes real bill paramount in the economy is the fact that, in the
aggregate, they constitute the wage fund of society. They alone make it
possible to produce and distribute goods now that the consumer will
only pay for later. Up to three months later, to be precise. However,
in the meantime workers employed in their production will have to be paid
their due wages every week. Indeed, these workers must eat and satisfy other
wants to be able to continue their production efforts. The payment of wages
is definitely not financed through savings of the capitalists. It is financed
through clearing, that is, through the spontaneous granting of temporary
monetary privileges to real bills, thus enabling them to circulate before
maturity.
An unintended consequence of the legal tender legislation was the destruction
of this wage fund out of which workers could be paid before the goods were
sold. Legal tender laws bore direct responsibility for the horrible
unemployment during the Great Depression ― as pointed out by Rittershausen. As long as the wage fund is intact, there
can be no unemployment. Everybody who is anxious to earn wages can go into
the production or distribution of some goods demanded by the consumers
urgently, and get compensation from the wage fund immediately, even before
his product is sold. The destruction of the wage fund changed all that.
Workers could no longer be compensated for their labor expended in the
production of merchandise unless it is ready for sale right away.
The destruction of the wage fund was not immediately
obvious in 1909. Military training and production of war materiel absorbed
the available manpower. During the war labor was in short supply because of
the vast expansion of the production of munitions. Unemployment hit society
only after the cessation of hostilities.
Had the victorious powers repealed legal tender laws
after the war, thereby rehabilitating the market in real bills and
replenishing the wage fund, the great Depression would have never occurred.
But the victors were not interested in multilateral world trade. They wanted
to punish the vanquished even more by making trade bilateral, to the
exclusion of real bill circulation. In this way they wanted to retain control
of the trade of their former adversaries. As a result the wage fund was never
resurrected and workers could not be paid. The result was the greatest
unemployment ever in history. Governments were forced to assume
responsibility for the unemployed through the dole system. This system, an
affront to people eager to work for wages, is still with us but its root
cause, the absence of real bill circulation, remains unrecognized.
*
* *
Legal tender laws, representing the unholy alliance
(not to say conspiracy) between the government and banks, have never been
repealed. Governments have come to love the extra powers they acquired
through false pretenses. The banks were happy to take the bribe. They shifted
their loyalty from their customers to the government. In exchange for the
privilege to create bank deposits without the restraint of a gold reserve, as
was the case prior to 1909, the banks were prepared to buy all the government
bonds that have found no willing buyers in the bond market. “You
scratch my back, I scratch yours.” This conspiracy still goes on under
a new ‘social contract’ in which bribe and blackmail has replaced
voluntary cooperation.
The connivance of academia and media, in particular,
the loyalty of the economists’ profession and that of financial
journalists, has been bought by the central banks’ eagerness to sponsor
research. “Whoever pays the piper shall call the tunes.” Authors
who were prepared to sing the praise of irredeemable currency were handsomely
rewarded. Authors critical of fiat money need not apply. Most of the
economists and financial journalists today are scribes for hire, selling
their pen to the government and the central bank. Propaganda is passed on as
research.
Mathematics has been prostituted as never before in
the history of the Queen of Sciences. Research papers on economics and
monetary theory studded with formidable-looking but otherwise vacuous
differential equations are presented as Holy Grail. The studied gestures and
hocus-pocus of latter-day economists is similar to those of the priesthood in
ancient Egypt. By virtue of their knowledge of astronomy ― knowledge
denied to the general public ― Egyptian priests could predict eclipses
of the Sun and other celestial events. They keep their audience in awe and in
fear of their supernatural powers. The difference is this: while Egyptian
priests were professionals representing state-of-art scientific knowledge,
mainstream economists are charlatans and quacks who, while basking in their
own glory, are totally incapable of predicting financial collapse even when
it is staring at them in the face, as their miserable performance in 2007
showed. Worse still, they are totally incapable to admit their own mistakes.
They are a curse on the body politic and a wart on the body academic. They
are leading the world into an unprecedented monetary and economic disaster
right now as I speak here.
*
* *
Our present financial crisis is the epitome of a
tragedy brought upon us by coercion in the monetary field. The way out of the
crisis, and the way to prevent another great Depression, is through the
restoration of freedom in the realm of money: through an adroit repeal of
legal tender laws. The gold standard must be rehabilitated together with its
clearing system, the bill market. The monopolistic nature of government debt
in the bond market must be eliminated through bringing back the competition
of the gold coin to the promises of the government. Bondholders dissatisfied
with the rate of interest offered by the coupons arbitrarily attached to
government bonds must have their rights restored to them: the right to park
their savings in gold coins, as they did before 1909. In this way they could
force the government to pay competitive rates of interest on private savings, All coercion in the monetary field must be
stopped. The dignity of the individual must be respected. The present
collectivistic frame of mind of the government must be discarded in favor of
one favoring the individual, restoring freedom and the free initiative of
man.
A century is just a fleeting moment in history. The
past one hundred years must be looked upon as a reactionary episode in our
civilization, a mindless experiment with irredeemable currency. The experiment
has failed miserably, as have all similar experiments in the past. Unless
stopped forthwith, it will plunge the human race in unprecedented economic
misery. It literally threatens the survival of our civilization and the
entire system of our values.
Freedom in the field of money will bring us peace
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