By the time that Congress intervened in the banking system again - in the Federal Reserve Act of 1913 - checking accounts had replaced bank notes as the preferred medium of lending as well as the method of payment most frequently used in commercial transactions. The Federal Reserve Notes that were authorized in 1913 (printed at the treasury and furnished to banks) were merely a convenience for customers of the bank who wished to pay for things in cash without parting with gold and silver coins. Compared to checking, these notes were of secondary importance. It was obviously easier to pay by check than send an armored car full of cash. The volume of checks that were written and deposited vastly exceeded the stock of Federal Reserve Notes - a crucial point to understand.
All national banks were required to join the new Federal Reserve System. Member banks had to park some of their reserve funds with the regional Federal Reserve bank. When a Federal Reserve bank needed currency to supply to its member banks -- which in turn would supply it to the customers who were cashing checks -- the regional bank would place assets on reserve as collateral for the Federal Reserve notes, which were treated as a loan. When the bank no longer needed to carry as much currency, some notes could be returned and the bank would get back some assets. The process is simpler today: banks buy as many notes as they believe their customers will need, and then their accounts at the Federal Reserve are accordingly debited. Banks also buy coins from the mint the same way. And the minting process itself has changed completely: the mint buys the metal that it needs to make coins, which have long since ceased to be pure gold or silver (except for commemorative pieces that are sold to collectors).
Now observe what has happened over two hundred years or so. From a system that was based upon the minting of gold or silver coins, which were placed in banks as a foundation for a larger "circulating medium" of paper (bank notes or checks), coins and even currency have been reduced to mere "chump change": representational tokens for a deeper source of purchasing power that is created by banks out of nothing. The Federal Reserve confirmed all this in 1939 as follows: "Federal Reserve Bank Credit ... does not consist of funds that the Reserve authorities 'get' somewhere in order to lend, but constitutes funds that they are empowered to create."
And that's the way our money is created nowadays -- through "credit" that is pulled by the Federal Reserve system out of nothing and sent to member banks and the public in the form of loans. Moreover, paper checks have become increasingly rare: most purchases take place electronically; both "the Fed" and the treasury department are moving toward an all-electronic system.
It's important to understand the way in which our bank-created money supply functions in order to contemplate proposals for radical change.
The historical, conceptual, and legal basis for radical change in our monetary system is the long-dormant American practice of creating new money by direct legislative action, money that (like bank-created "credit") is pulled out of nothing but then gets spent -- not lent -- into circulation.
The printing of money to be spent into use by government is a practice that dates back to colonial America. The colonists were often literally cash poor in terms of circulating coin and the commercial banking profession was still in its infancy on these shores. Benjamin Franklin helped pioneer the method of "printing press money" in Pennsylvania.
Legal-tender paper money was created by the Continental Congress in the American Revolution. The Civil War was partly financed on both sides by the issuance of paper money, which was spent into use. One pernicious side effect of this money creation by government was inflation: soaring prices, caused at least in part by the reluctance of creditors to accept payment in bills that were not backed by coin. Even though people under law were obliged to accept the new "United States Notes" that were created pursuant to the Legal Tender Act of 1862, they often
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accepted them at depreciated rates, which caused prices to rise: a barrel of flour that might cost five dollars if purchased in coin or in reliable bank notes might well cost ten dollars if purchased via government "greenbacks."
The constitutionality of the Legal Tender Act was challenged, but in 1871 the Supreme Court upheld it in the case of Knox v. Lee. Thereafter reformers and a short-lived Greenback Party advocated the use of United States notes to pay for programs designed to create jobs or bring other forms of economic relief to farmers and workers. But the orthodoxies of Gilded Age finance precluded such action.
During the Great Depression of the 1930s, some of America's most distinguished economists -- John R. Commons, Irving Fisher, Laughlin Currie, Henry C. Simons, and Richard Lester -- called for the issuance of "greenbacks." Their particular proposals differed, but the common denominator was the principle of government-created money. In 1933, Congress made limited provision in the Agricultural Adjustment Act for the issuance of new United States notes at presidential discretion, but FDR declined to use that authority.
Since the Great Depression, a number of mavericks have proposed reviving "the greenback." Some have advocated abolishing bank-created money altogether in favor of government "fiat money." Others (including myself) have argued for a mixed system, a best-of-both-worlds resolution with the authority to create new money shared by the banking system, capped by the Federal Reserve, and Congress.
My proposal builds upon and extends the mechanics of the status quo. To wit: bank-created money is summoned out of nothing and sent in the form of loans through direct electronics. The small amounts of cash that we use from time to time for "chump change" transactions are provided to the public via banks. My proposal: keep this system, and persuade the members of Congress to vest themselves with the same kind of power to create new money out of nothing that bankers possess, but with a simple and crucial difference. The money created by Congress would be spent (not lent) electronically into bank accounts of government employees or vendors.
Twin streams of money creation would thereby emanate from Congress and the Federal Reserve. And these streams would converge to form a common monetary pool in the accounts of the banking system. The benefit: a built-in contra-inflationary capability. The Federal Reserve, through its operational methods (the manipulation of interest rates, the raising of reserve ratios, and the use of "open-market operations," consisting of the buying and selling of bonds), has a dazzling array of techniques through which inflation can be counteracted. Under Paul Volcker's chairmanship, "the Fed" had great success in taming the inflation of the late 1970s.
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