Our fate, initially predetermined by the circumstances of our birth and then seemingly left to our own devices, is constantly changed by intervening chance events and by other people's acts of will. Rational inevitability in history, so eagerly embraced by the Communists, was never anything but a product of the late Mr Hegel's imagination. Each chance event or act of will that affects our lives is like a flip of the coin. It makes history go one way or the other.
The flip of the coin that led to the introduction and the passage of the Federal Reserve Act in 1913, took place in Victorian England of the 1860s.
England of that era was an oligarchy where the very few had it all, and the very many were kept in the state of permanent servitude with masterful policy of exclusion, based on prohibitive cost of education and fraudulent democracy. Under two-party system in which both parties were controlled by the privileged few, the sole purpose of elections was to determine who would be deceiving the dispossessed next.
As long as the masses were deprived of quality education and meaningful political representation, the only challenge to the ruling class could come from abroad in the form of a military invasion. But because England was an insular nation with the largest navy on the planet, no such invasion was possible as long as the continental nations were divided.
For this reason, England's foreign policy always sought to prevent political unity on the continent by inciting coalition wars against nations currently aspiring to hegemony. This policy of "balance of power" gave the British Empire some ten generations of time to develop and flourish until the fateful error in the 1860s would open for the Prussian "minister president", Otto Bismarck, a window of opportunity to unify Germany.
Edward Crankshaw mentions in his biography of Bismarck, that while serving as Prussian envoy in Paris, Bismarck paid a summer visit to London in 1862, during which he advised Benjamin Disraeli, then in opposition, that he, Bismarck, expected to be appointed prime minister of Prussia, that it was his intention to eject Austria from Germany in order to give "smaller Germany" a new unity under Hohenzollern dynasty, and that he wanted queen's ministers to know about his plans.
Whether because they were taken by the feigned candor of Bismarck's expose or simply for want of a better policy at the time their attention was deeply distracted by the Civil War in America, a fallacious belief filled the ruling hats of London that once the dust would settle upon the Austro Prussian quarrel things would remain very much the same in central Europe, except that Prussians rather than Austrians would do the talking in the ceremonial German Diet in Frankfurt.
And so, Palmerston, Russell, Derby, Disraeli and Gladstone watched in succession from the sidelines as Austria and Prussia took Schleswig-Holstein from Denmark, as Austria was then ousted by Prussia by way of a bloody battle of Sadova, and as Germany was swiftly integrated into the Prussian system in which the Government was little more than a department of the General Staff. Taking sides in the internecine German convulsions may have seemed all the more redundant, that it was France and Russia rather than Austria or Prussia that were traditional candidates for continental hegemony. It was to cut Russia to size and thus restore the balance of power, that England joined France and Turkey in expedition to Crimea only few years earlier.
It wasn't until Napoleon III capitulated at Sedan on September 1, 1870, and new German "Reich" was proclaimed in Versailles under Wilhelm I as "Kaiser" on January 19, 1871, when the reality of Bismarck's intentions finally dawned upon the brightest of London. On February 9, 1871, Disraeli, again in opposition, announced in Commons the end of an era: "The balance of power has been entirely destroyed."
Two weeks later, Bismarck imposed upon the French Republic, which succeeded the defeated Empire, a horrendous indemnity of five billion francs (46,675,000 troy ounces of fine gold). German hegemony in Europe was now a fait accompli, and it would only be a matter of time when French gold would accelerate industrial expansion of Germany to the point when challenging Britain for world supremacy would become economically feasible. Bismarck's witty remark that if the British soldiers would dare to land on the continent he would have them arrested, defined the new reality clearly enough.
For British imperial rulers this was a nightmare. Their security and their way of life seemed always as preordained as sunrise and sunset. Now, all of the sudden, their empire was reduced to what lawyers call an "estate at sufferance", no longer respected but merely tolerated by the obnoxious Prussian Junkers until they were ready to gobble it up.
In post-Sedan years, as German industrial might grew by leaps and bounds, British free-trade policy was attracting so much of German exports that before long Germany became Britain's main trade partner. This economic appeasement was rooted in yet another fallacious belief that as long as Germany would have unrestricted access to British imperial markets, she would leave well enough alone.
Thirty years down into this drift, the new generation's free-trader, Winston Churchill, entered the political scene by assuring his countrymen that trade between nations "binds them together in spite of themselves, and has in the last thirty years done more to preserve the peace of the world than all the Ambassadors, Prime Ministers, and Foreign secretaries and Colonial Secretaries put together."
Bismarck played into the British free-trade policy with great skill by avoiding unnecessary military demonstrations. There was no percentage in provoking anyone when Germany was the fastest growing country in Europe and with patience was likely to swallow the whole continent economically. But Germany's new emperor, Wilhelm II, was not a patient man, and in 1890 he asked for and received the Iron Chancellor's resignation. German foreign policy then became openly antagonistic to Britain, and after a decade of Wilhelm's "Weltpolitik" German navy became second only to Britain's.
Threatened Britain negotiated "entente cordiale" with France (1904) and judiciously settled her differences with Russia (1907). But even combined forces of this Triple Entente were clearly insufficient to defeat German challenge outrightly without help from America. This is the key point without which English policies toward America simply cannot be understood.
In order to preserve their global empire from perceived imminent destruction by Germany, the English gentlemen fashioned for themselves a task to win the war the size of which the world had never seen before. To be sure, they did not seek that war for war's sake. The best summary of their state of mind came from the same Winston Churchill: "War is terrible but slavery is worse."
England's renewed interest in America had nothing to do with colonial sentiments or historic revenge. England had to have America back, because only American economy was big enough to finance the war for the British Empire.
Already on February 5, 1891, in the aftermath of Bismarck's resignation, a secret society was formed in London to mobilize English speaking world by covert action for the incoming life and death struggle with the imperial Germany. The leading organizer was Cecil John Rhodes, who was splendidly succeeding in monopolizing South African diamond and gold mining industries under gigantic umbrella organizations (De Beers Consolidated Mines and Consolidated Gold Fields), and who in his spare time also served as prime minister of the Cape Colony. (Extensive additions to the British Empire along the Cairo-Capetown railway would quite fittingly be named Rhodesia.)
In his monumental "Tragedy and Hope", Georgetown University historian (and Bill Clinton's mentor) Carroll Quigley wrote that Cecil Rhodes' secret society was formed under influence of John Ruskin's lectures Rhodes heard as a student at Oxford, in which the famous professor had called for extension of English upper classes "magnificent tradition of education, beauty, rule of law, freedom, decency, and self-discipline ... to the lower classes in England itself and to the non-English masses throughout the world."
But the famous banker, John Pierpont Morgan, whose name will surface here time and again, used to say that "for all things people do there is good reason and the real reason." While Professor Ruskin's flowery appeal was without doubt a good reason for establishing Cecil Rhodes' secret society, it was not the real reason.
Cecil Rhodes' secret society plotted the Jameson Raid of 1895 against sovereign Boer republics, Orange Free State and Transvaal, and it caused the Boer War of 1899-1902, in which concentration camps were used against civilian population on massive scale for the first time in history. Cecil Rhodes' secret society was not created to teach the Boer men women and children in English concentration camps about English "education, beauty, rule of law, freedom, decency, and self-discipline". It was created to mobilize English speaking world against Germany. Seizing the gold of Southern Africa per fas et nefas was merely a part of that struggle. The key objective was to acquire full control over the finances and the industry of the United States. The Boer War served adequate notice upon everyone in London what would it take to win a modern war. Only America had the financial and industrial capacity England needed to defeat Germany.
In retrospect, we can tell what the exact cost of the First World War was, and thus we can be very specific about British financial requirements. Total direct cost of the Great War of 1914-18 on the side of the Entente was $125,690,477,000, while the Central Powers spent only $60,643,160,000. Entente outspent the Central Powers by 2:1 and the outcome remained undecided until the last few weeks of the war. The American contribution was $32,077,253,000, one-fourth of the Allies total: $22,625,253,000 in US own expenses and $9,452,000,000 in loans to the Allies ($4,316,000,000 to England alone).
To make the long story short, England had to find the way to raise in America thirty-two billion dollars in order to beat the German challenge.
As of the date of her Gold Standard Act of March 14, 1900, America had all kinds of money in circulation, but only gold coins were recognized as legal tender without limitation.
Five coins, made of gold 0.900 fine, were in circulation:
One Dollar ($1), made of 25.80 grains,
Quarter Eagle ($2.50), made of 64.50 grains,
Half Eagle ($5.00), made of 129 grains,
Eagle ($10.00), made of 258 grains, and
Double Eagle ($20.00) made of 516 grains.
One troy ounce of fine gold was worth $20.67183462.
Silver dollars, made of 412.50 grains 0.900 fine, also enjoyed the status of legal tender, but could be excluded by express stipulation in the contract. (Large sums in silver dollars were simply too heavy to carry.) Subsidiary silver (halves, quarters and dimes) had to be accepted in payment only up to the amount of $10, and token coins (nickels and pennies) up to 25 cents.
United States notes, originally introduced by President Lincoln to finance the Civil War, were recognized as legal tender for all debts public and private, except for duties on imports and interest on the public debt, which had to be settled in gold.
Treasury notes of 1890 had the same status as silver dollars (full legal tender except where otherwise stipulated in the contract). Authorized by the "Sherman Silver Purchase Act", these notes represented silver bullion in US Treasury, and were gradually redeemed by newly coined silver dollars, or the more convenient silver certificates. Only in a few Western states silver dollars, often referred to as "cartwheels", were used in daily commerce. Rest of the country was satisfied with "paper dollars". Minting of gold One Dollar coin was discontinued already in 1890, and even Quarter Eagle was later displaced with one-dollar and two-dollar silver certificates, which became the "workhorses of daily circulation". The remaining three gold coins, $5 Half Eagle, $10 Eagle, and $20 Double Eagle, remained in open circulation until 1933, when all monetary gold was nationalized by Franklin Delano Roosevelt.
Gold certificates and silver certificates, which represented gold and silver coin on deposit in US Treasury, were not legal tender but were receivable for all taxes, customs and public dues. Unlike the US notes or national bank notes, they circulated in lieu of equal amount of coin, and thus did not expand the overall amount of money in circulation. For every gold or silver certificate of say $20.00 face value, a gold double-eagle or twenty silver dollars had to be withdrawn from circulation and deposited in US Treasury.
National bank notes were not legal tender either, but were receivable for all public dues, except duties on imports, and US government could not use them to pay interest on public debt or to redeem US notes. Even though they were issued by Comptroller of the Currency against deposit of US bonds (not to be confused with US notes), they were still required to be redeemed in gold coins on demand, for gold coins were legal tender and bank notes were not.
When Gold Standard Act became law, the amount of currency in circulation had just passed the two billion dollar mark. Rounded off by category to the nearest half a million dollars, it consisted of the following:
$715.5 million in gold coins.
$210.5 million in gold certificates;
$410.5 million in silver certificates;
$84.0 million in Treasury notes (unminted silver);
$322.5 million in US notes, secured by the redemption fund of $150 million in gold at the Treasury;
$257.0 million in national bank notes, secured by a deposit of $219 million in US bonds and $38 million in lawful money.
Gold and silver money in circulation was only a small part of the overall money supply. Several times greater part consisted of demand deposits the banks created simply by extending loans to their customers.
When a businessman borrowed $100,000 for three months from his uncle to finance his inventory, $100,000 from the uncle's account went to the businessman's account, and the total amount of bank deposits remained unchanged.
But when the same businessman borrowed $100,000 from his bank, $100,000 appeared in his account, and neither his uncle's nor anyone else's account was reduced by $100,000.
Where this additional $100,000 deposit came from?
Banking, like insurance, was based on actuarial principle. Imbalances between deposits and withdrawals could be predicted from actuaries' combined experience tables in the same manner as life insurer's exposure could be predicted from mortality tables. Only a certain fraction of the existing deposits was eventually withdrawn in cash. Bankers kept this fraction in reserve (fractional reserve) and lent the rest to the borrowers.
When the fractional reserve was 20 percent or one-fifth, every banker would lend 80 percent or four-fifths of all deposits on hand. But because the same amount still remained in the accounts of the original depositors, the loans would create new deposits that did not exist before. The borrowers were given 80 percent of deposits the bank had on hand at the moment, while the original depositors could use the same money at the same time by paying their bills by checks or bank notes, rather than by gold or silver coins. Checks or bank notes were considered a form of payment, but sensu stricto they were only the vehicles for moving gold, which was the real payment. And this was the whole secret of the banking business under gold standard. Only in banking, one could eat one's cake and have it too.
In our example, the businessman's account was credited with $100,000 that was not withdrawn from anyone else's account. Our businessman received a part of 80 percent of other people's money while other people's accounts were not reduced by that amount, and $100,000 were added into the nation's money supply thereby.
When our businessman then wrote a check for $100,000 to his supplier, and supplier deposited it in his bank, the supplier's bank kept $20,000 in reserve and lent $80,000 to another businessman. When deposited in yet another bank, $64,000 of that $80,000 loan became still another loan to someone else. In the end, the $100,000 loan to our businessman produced about $400,000 in new deposits all across the nation.
When our businessman's bank lent $100,000 of other people's money to him, the net effect of this action was $500,000 in new deposits. (With fractional reserve set at one-sixth, one-seventh or one eighth, the new deposit money in circulation was $600,000, $700,000 or $800,000.)
And when our businessman repaid his loan, the sum total of bank deposits (and the overall money supply) was reduced by $100,000, but the $400,000 in descending deposits were not extinguished thereby; they remained on the books until duly repaid. Meanwhile, new deposits for new loans were being continuously created in order to keep the overall money supply undiminished. Otherwise, the inventories against which the loans were being made could not be sold.
This continuous creation and recycling of bank deposits is what makes capitalism possible, and there is nothing inherently wrong or sinister about it. The canard that fractional reserve banking is inherently evil was slipped into circulation most likely to sow confusion among proponents of the honest money.
For purposes of our argument here, it will suffice to grasp that under gold standard as it existed in America at the turn of the centuries the overall money supply depended on two factors:
1. The sum total of currency in circulation, and
2. The percentage of the fractional reserve margin (which determined the sum total of bank deposits).
Under American gold standard system, where gold was the only legal tender without limitations, and all forms of "paper money" were redeemable in gold (silver certificates in silver or in gold at the Treasury's option) on demand, the supply of money was finite. American bankers, unlike their English counterparts, could not create new deposits beyond the natural limit imposed by the percentage of the "fractional reserve". Banks that would create excessive deposits would be unable to redeem their paper, and would have to close down.
J.N. Tlaga
tlaga@shadow.net
Copyright 2000 J.N. Tlaga
January 4, 2001