A while back I started to wonder why the British Pound was called, the Pound. It turns out, the pound was whatever a pound of silver was worth. It was packaged in nice, neat coins by the government, so you knew that when you had one it was probably the real thing, not short in weight, and not diluted with cheaper metals. A pound of money was a pound of silver, but that was 1200 years ago. It's fallen a bit since then.
It's still called the Pound Sterling, but the connection with sterling silver is no longer obvious.
King Offa of Mercia, in the Eighth Century, first created these Pounds, but he modelled them on previous coins. In fact, one source maintains he overstruck dirhams to make two-penney pieces. The dirham (درهم) is a silver coin used in the Middle East. Middle Eastern coins circulated not too uncommonly throughout Europe at the time. The original silver penney was about 1.5 grams of silver. 12 pence = 1 shilling, and 20 shillings = 1 pound. These were a different pounds than our pound today, they weighed about 350 grams and are known as “tower” pounds.
In some other parts of Europe, gold and silver was commonly measured in marks, hence the name of the German currency of the same name.
Another common currency of Europe was the livre, which is of course the French word for “pound”. It, too, was a pound of silver, although that pound was somewhat lighter than the tower pound. The livre was divided into 20 sous, each of which were divided into 12 deniers. This was the same scheme used by Offa, who borrowed it from the French. Thus, the sou was the analog of the shilling, and the denier the analog of the penny. The franc was a specific coin, minted later, with a value of one livre, so the French currency is based on the same general system.
Spain, by contrast, has a more complex currency history. The old units of Spanish money dating to the same time as the pound, the mark, and the livre, aren't with us any longer. Although England and France and, for that matter, all of Europe, debased their currencies over time, the situation in Iberia was worse. Only with the plunder of the new world, beginning in the late Fifteenth Century, was Spain able to stabilize the value of its currency. At that time, the unit of currency was the real, and eight of these constituted a Spanish “dollar”. The word, dollar, is actually a shortening of the name of a Bohemian coin first minted in 1520. After a while, a lot of other coins became known as thalers, or tolars, or dalers, or talleros, or daelders, or — in English — dollars.
The eight-real coin, having about an ounce of silver, was called peso de ocho, “weight of eight”, in Spanish. That's whence the expression “pieces of eight“ comes. Why did the United States chose the dollar as its currency, instead of the pound? It was simple: there were more Spanish dollars in the colonies than there were pounds. World wide, Spanish currency, of high and consistent quality, set the standard for the rest of the globe. It even circulated in China. The American colonies were no exception. Virginia's first official currency was the Spanish real, and the first coins minted — at the Tower of London, in England, by Royal Patent — specifically for the colonies were denominated in reales.
Of all of the complaints the Colonists had against the English Crown, the money situation was the strongest. England tried to limit Colonial access to currency, to control trade, and made the situation even worse. Benjamin Franklin once said that currency problems were the main cause of the American Revolution. Each Colony issued its own currency, and there were serious problems with debasement of these currencies, but English attempts to regulate Colonial currencies served to anger the Colonists.
Even after the Revolution, the Spanish dollar continued to circulate. In 1793, Congress made it legal currency, alongside the United States dollar. The reason that the New York Stock Exchange reports prices in eighths, since it opened in 1792, was that the exchange originally reported prices in New York shillings, which were pegged at eight to the Spanish Dollar. Some early United States coins had a denomination of 12 and one-half cents: that's an eighth of a dollar, one real. The letter “S” which forms the basis of the “dollar sign” ($), is the first letter of an earlier notation, based on the letters S and P, for Spanish Peso. At first, the P was written over the S. Eventually, the P became a simple line, leaving $.
At first, the United States only issued specie. By one of the first acts of the new Congress, a mint was built in Philadelphia. Anyone could take in gold or silver, and trade it for specie. At first, there was no charge for this service, but later a small fee was charged. Although new Spanish dollars weighed 377 grains, Alexander Hamilton weighed an assortment of worn, circulated Spanish dollars, which weighed less, and decided that the United States dollar should have the same weight in silver: 371.25 grains, which gave silver a value of about US$1.29 per troy ounce.
Although the U.S. Dollar was defined in terms of silver, the new Mint also issued gold coins, called Eagles. At first, the price of Eagles was set at ten dollars per Eagle, a 15:1 ratio in the price of gold per ounce to the price of silver per ounce. This reflected the market value of gold in terms of silver. Congress later made adjustments, as the price of gold rose relative to silver. By 1837, the ratio was 16:1. The dollar was still tied to the price of silver, but the government was authorized to pay bills and to accept taxes in gold at the rates specified by Congress.
Beginning in July of 1861, to finance the Civil War, the government issued Demand Notes, which were redeemable on demand for specie. However, too many people actually tried to redeem them, so redemption was suspended by the end of the year. By law, they could still be used for payment of taxes, and by the middle of 1863, almost all of them had been used to pay taxes, and were no longer in circulation.
Still needing a way to finance the War, the government then issued, beginning in February of 1862, notes which had no silver or gold backing them. The promise without specific terms was that they would be redeemable after the War. They traded up and down, floating against the dollar, partly depending on how the war was going. Eventually, the became redeemable in 1789. These notes were called United States Notes, but were informally, along with the previously-issued Demand Notes, commonly known as “greenbacks”.
Starting around the mid-1800s, world silver production began to increase, which had the effect of depressing the value of silver relative to that of gold. Countries around the world didn't want to accept silver, and began switching to gold standards. Eventually, in 1873, the United States began refusing to accept silver, taking only gold for settlement of debts. There were great complaints from a number of corners, because this effectively deprived silver holders and silver producers of wealth. Eventually, the government agreed to buy a certain amount of silver at prices higher than the market, beginning in 1879.
The situation was a little more complex than this: the Coinage Act of 1873 only suspended the government's acceptance of silver. Officially, the dollar was based on silver, but in practice, it was based on gold. Eventually, in 1900, the switch to gold was officially made, and even silver certificates were redeemed in gold. By 1908, the gold:silver price ration had reached 40:1.
Thus, from 1792 until 1908, the United States dollar was more or less the same as gold or silver. You could think of it as another unit of weight, as in, a dollar (about three-fourths of a troy ounce) of silver, just as you might have had a pound (twelve ounces) of silver or a mark (eight ounces) of silver.
The United States government has been in debt since the beginning, when it acquired the debt of the Revolutionary War. That debt reached a low in the 1830s, during the administration of Andrew Jackson. For two years of his term in office, it was practically zero. But it didn't stay there.
Time after time, monarchs get themselves into corners, into binds and predicaments, and had to go to bankers for money to finance wars or to meet other demands. After a time, the United States went the same was as the kings and republics of the past.
The first big foray into currency debasement came with the Civil War. The government was desperate for money, and it took it from the people at large by debasing the currency. At first, it had approached the bankers, but they wanted too much interest, so Lincoln refused to deal with them. Lincoln ended up hating the bankers. After the Civil War, the government ultimately redeemed the United States Notes and the Demand Notes, but it was still in debt, and it had acquired a taste for living beyond its means.
The public debt, however, wasn't the biggest problem as seen by most people. The biggest problem was the cycles of expansion and contraction: periods of prosperity, crises, panics, and so on, all mixed together in unpredictable ways at unpredictable times. It was too chaotic for some people, although there were a substantial number who believed that the markets should rule, and that the price of financial democracy included this unpredictability. The big bankers, on the other hand, complained about the inelasticity of the money supply: they couldn't get their hands on money at the times they wanted it. It wasn't merely the amount of money: it was the location of the money. The reserves were scattered about the country, but the big bankers were in a relatively few major cities. There was no way to move money from the outlying areas to the banking centres. Money was essentially gold, and by design the money stayed near where it was deposited, because it was your money, not the bank's, so why should the bank take your money from Kansas to New York City just because he wants to use it there? The reasons for the situation were complex, and quite interesting, as well. However, if I go there, we will be sidetracked by politics, and we'll not return to our primary theme, which is the backing of the dollar.
It should be noted that money and banking were institutions of considerably more variety than they have today. From the beginning, anyone could issue money: the Colonies did, but so also did banks. Those Demand Notes issued by the U.S. to finance the Civil War weren't new: private banks had been issuing paper demand notes since before the Revolution. You could pay for your supplies with a private bank note, not only with Colonial scrip or specie, as long as the merchant would accept it. The ultimate traceability of the value of all currency to silver and gold held the system together, and allowed it to work. So when your hometown bank issued you a demand note in return for gold, the gold stayed in your home town. There was not so much of this tendency we have today, for money to flow to Washington and to the financial centres.
Primarily to address the issues of money supply inelasticity and money immobility, the Federal Reserve system was set up in 1913. Twelve regional Federal Reserve banks were created, and nationally chartered private banks were required to purchase the regional reserve banks. Yes, the Federal Reserve banks are privately owned, despite the system's appearance as some kind of government institution. The national banks even get dividends from their stock in the Federal Reserve banks. (As an aside, when a private bank is owned by foreign interests, then, indirectly, those foreign interests own part of the Federal Reserve.) Although the Federal Reserve is owned by the private, national banks, the management is subject to the approval of Congress, and the government has a lot of control over the system.
Effectively, the Federal Reserve banks became “super-banks”, banks for bankers. They dealt with the money supply problems by being able to lend money to the under-banks when the under-banks got into trouble and couldn't cover their debts. This, in turn, stabilized the system, and indirectly protected the depositors by reducing the risk of bank failure.
The Federal Reserve Act of 1913 authorized something else: the issuance of Federal Reserve Bank Notes. Each of the twelve reserve banks could issue money. These weren't simple demand notes, where you could take them to the Federal Reserve and ask for gold. Instead, you took them to the Treasury to redeem them, but the redemption might be in gold or other money. In other words, you might get a note for a note. On the other hand, the Federal Reserve bank was required to keep Treasury notes in its vaults to back up the Federal Reserve Bank notes. Treasury notes are obligations of the U.S. Treasury, so the Federal Reserve bank notes were backed by government promises. To put it differently, instead of gold, the notes were backed by IOUs. The redemption for gold by the Treasury was stopped in 1933; after then, the Treasury would give you only change in other notes. In 1971, the name was changed to Federal Reserve Note by taking out the word “Bank”, and they are now backed by the reserve banks collectively rather than by one reserve bank individually.
A bank note is basically an IOU in the first place, as in “I owe you some ounces of gold, which is in my vault, stop by sometime and collect”. The Federal Reserve Note is an entirely different level of obligation. Having a Federal Reserve Note in your pocket is akin to a note from the Federal Reserve, saying, “We don't owe you anything, but the United States government owes us. You can't go anywhere to collect on this, but the law requires you to accept it, and the law requires anyone else to accept it from you.” This kind of money, backed by nothing and having no intrinsic value, is called fiat money, from the Latin, for “let it be done”. It's money by edict or decree or order.
In 1933, the U.S. government did not merely stop redemption of paper currency for gold. It went beyond this, outlawing possession of gold: possessing or trading in gold anywhere in the world by a U.S. citizen became a criminal offense. Americans were forced to sell their gold to the Treasury. The next year, the price of gold was adjusted upward, from US$20.67 to $US35, which was the same as devaluing the dollar by 41 percent. In 1975, after the dollar had lost over 86 percent of its value since 1933, Americans were again allowed to buy gold with their cheapened dollars. Although, after 1933, domestic gold ownership was criminalized, the government continued to use gold internationally in settling debts to and by other countries.
Those paper Federal Reserve Notes are obviously not the bulk of dollars in circulation. The amount of money on deposit at banks vastly exceeds the amount of paper currency. Whence comes all that money?
There are two kinds of money: the government created money we have been talking about up to here, and other money not created by the government. The various measures of money, such as M0, M1, M2, and so on, measure the different kinds of money. Approximately, M0 or MB, depending on which system you use, is the government money, including things like coins and Federal Reserve Notes. (M0 is cash and coins, MB adds Federal Reserve deposits, more or less.) M1, M2, M3, M4, L, and MZM include M0 and MB, but also add the non-government money. Currently, M3 is about five times the size of M1.
The non-government money is made by banks. They create it, essentially, out of thin air, out of nothing. Here's how it works. When a basic demand note is created, the bank takes silver or gold and gives out some kind of note, which can be exchanged on demand for the gold or silver. The person who holds the note can spend it, sit on it, or keep it. Assuming the amount of the transaction was fifty dollars, the bank's balance sheet has a $50 asset (the silver or gold) and a $50 liability (the note). It balances out: assets equal liabilities, and life is good. Suppose, instead, you go to a modern bank (ignore those throwacks who deal in gold!) and borrow $50. The bank opens an account for you, and puts $50 into the account, and you give the bank a promissory note or IOU or some other kind of paper saying you'll pay by some date. In this case, the bank's balance sheet has a $50 asset (the IOU from you to the bank) and a $50 liability (the balance in your new account). The IOU is an asset, it has value, it might be sold to an investor or whatever. The account balance is a liability, because the bank owes you that money. It's your money.
Notice two things about this loan transaction: the money came from nowhere, and the backing for the money in your account isn't gold: it's an IOU. The bank did the same thing the Treasury or central bank would do: it traded dollars for an asset. The asset was a note, not silver, and the dollars were put into your account electronically, not with a printing press. In some old Westerns, the Sheriff goes out in and deputizes some of the townspeople when there's some kind of crisis. (Actually, this sometimes happens in real life, too.) In this case, the Treasury has deputized the Federal Reserve, and the Federal Reserve has deputized the banks. So the banks are making dollars, as a surrogate for the government.
Once that new money is in your account, it's indistinguishable from $50 created any other way. You can go to an ATM and get a Federal Reserve Note for it. If 80 percent of the money is created by banks, then, effectively, 80 percent of Federal Reserve Notes are backed by loans similar to the loan the bank gave you. Our currency is fungible with bank-created money, so it's not backed by gold, or by Treasury notes, or by any such thing: it's backed by you. If you default and don't pay your debt, then the money goes bad. Now think of what all of those bad home loans did: they didn't just hurt the banks, they jeopardized the very dollars which lubricate the economy. All of those home loans gone bad were like an enormous bonfire, turning Federal Reserve Notes into a thick column of smoke.
If the U.S. Mint gives me dollars or Eagles for my silver or gold, then that's pretty cool. If the Bank of XYZ wants to mint shillings, and can convince anyone to take them, then that's free enterprise. But when the Bank of XYZ mints dollars, who are we going to tar and feather when it goes bad? The bankers? Congress? The Treasury Secretary? Or all of them? Or do we dive into the fire ourselves for being so stupid or cowardly as to let it happen in the first place?
To add insult to injury, when you take out a loan, the bank charges you interest. Because those green pieces of paper from the Federal Reserve are blended with the loans by banks belonging to the Federal Reserve, the money in your pocket isn't free. It's not even your money, or the government's money. It belongs to the Federal Reserve, which is owned by the nationally chartered banks, and you're paying rent on it. Without going into the maths involved, the biggest component of inflation is interest paid on loans. You may not be taking out your wallet to pay interest to the Federal Reserve on those notes in your pocket, but they're worth less each day as inflation takes its toll. That's your rental payment to the banks.
Two centuries ago, the dollar was worth about a twentieth of an ounce of gold. One century ago, it was worth about one twentieth of an ounce of gold, but getting that gold was becoming problematic. Now, it's worth about one thirteen-hundredth of an ounce of gold. It has lost over 98 per cent of its value, steadily, over the last century, especially since the 1933 confiscation.
There's a line of thinking that the government is too big and inefficient, that it's incompetent to handle certain functions. Some think that it's best to contract out the government's jobs to private enterprise. Let the lowest bidder handle garbage collection, water and power, maintaining government buildings, spying on foreigners and citizens, and managing the currency.
I'm inclined to believe that if the government can't handle it, it should stay out of it all together. If the government can't do these things, then don't hire a contractor, don't do it at all. Let the people in a neighbourhood come up with their own plans. That's what democracy is supposed to be about: the people running things. As, for example, when the people decide how many dollars should be in the money supply by choosing whether or not to take their silver to the mint.
Perhaps we got a little elasticity and mobility for our money supply. Perhaps we avoided a few recessions. But we lost almost all of the dollar. Along with fewer recessions, we got a little less growth overall. The corporations which strangled the working class in the late Nineteenth Century are still with us, only bigger and more powerful than ever before. We are slaves to government debt, to medical debt, to student debt, to mortgage debt, to credit card debt. We pledged our souls to the banks. The coins say, “In God We Trust”. Of which god do they speak?
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