“‘Tis DEATH to Counterfeit”

T he warning above was printed on Maryland paper money in 1774, and on similar notes issued by other North American colonies along the Eastern seaboard. That was during the period culminating in the American Revolution. Among other things, it indicates that legitimate political entities had by then realized they had the power to make something besides gold and silver serve as money. By the time the 13 original colonies declared their independence from Great Britain, the Continental Congress itself had joined them in authorizing 42 successive issues of Continental paper money. Thence stemmed the expression, “not worth a continental.” What had transpired in addition was the British waging economic warfare by shipping boatloads of counterfeit continentals into eastern ports and into circulation. Such actions together brought about what inflation – let alone counterfeiting – eventually accomplishes: the value (purchasing power) of such money will decrease and can eventually vanish! In other words, aside from its role as a medium of exchange and a standard of value, another essential function of money – to serve as a store of value between the two sides of an exchange transaction – can fail entirely, as it did in Germany in 1923!

Fast forward now to the USA today. The last time our country and leading nations of the world suffered major economic catastrophe, the problem was not inflation but deflation: an inordinate reduction in the money supply not accompanied by a corresponding decrease in the amount of goods and services available. That came on quite suddenly beginning in 1929. It resulted as the commercial banks stimulated the stock market at the same time that they enriched themselves by investing their depositors’ money in it. That lasted until they could no longer sustain the speculative orgy which they helped to incite. By the time the economy bottomed out, the number of banks had decreased by one-third. This was before deposits were insured – first temporarily in 1933, and then permanently by the Banking Act of 1935. Amid the tumult, the volume of demand deposits in commercial banks decreased accordingly by approximately one-third, as did the price level. That horrendous experience – with unemployment soon reaching 25% of the work force – demonstrated the danger in modern economic life of having the commercial banking system serve as the leading money issuer.

Such significant tinkering with the monetary system, following the stock market crash in 1929, and the subsequent collapse of the national economy into the Great Depression, gave rise to serious discussion in academia among some distinguished scholars. These included two outstanding economics professors – Irving Fisher at Yale University and Paul Douglas at the University of Chicago. The latter was one of several faculty members at that university who, after their continuing examination of the monetary system following its collapse, came to be known as the Chicago School. Douglas reached the conclusion that it was time to separate private commercial banking from the money creation process. In his book Controlling Depressions (1935), he cited the Chicago group under the leadership of H.C. Simons as offering the “ablest proposal” for accomplishing that goal as outlined in a modest 40-page pamphlet entitled: A Positive Program for Laissez Faire (1934). Later Douglas served with distinction for 18 years as a United States Senator from Illinois. (Prior to that he had earned two Purple Hearts following enlistment in the U.S. Marines at the age of 50 after the attack on Pearl Harbor.)

Working separately at Yale, Irving Fisher too credited Simons and the Chicago School with doing outstanding work in this area of monetary economics. He himself already ranked among the leading original American contributors to the economic science. When the great collapse in the American economy occurred in 1929, Fisher turned his talents to examining the flaws in our monetary system, which seemed to him to lie at the root of the ensuing chaos. He wrote several books on the matter in a fashion that non-professionals could understand. One, entitled 100% Money, appeared in 1935 and presented basically the same conclusion that the Chicago group had reached. Commercial banks operating for their own profit had to be stripped of their power to create money, which is the proper domain of the federal government. They accomplish this inasmuch as they are allowed to lend out money deposited in demand deposits thus multiplying such money by an amount that varies depending on what the banks are required to set aside as reserve. (There was a formula established by Professor C.A. Philips [Bank Credit, 1926] which economics students used to learn; it indicated how much demand deposits could be ex­panded by the banking system.) Irving Fisher in his book termed the outcome of this predominance of the commercial banking system in the monetary process as “the mob rule of thousands of little private mints” (19). He suggested replacing such “mob rule” with control of the money supply by a Monetary Commission of the federal government. That would, among other things, restore to Congress a power assigned to it by the U. S. Constitution. The criterion for issuing/withdrawing money from circulation could be the maintenance of the stability of an appropriate price index by the proposed Monetary Commission. Fisher had already done significant work on the development and use of index numbers.

While typical contemporary economists may prefer to critique a monetary system on the grounds of efficiency alone, my mentor at St. Louis University, Bernard W. Dempsey, a Jesuit priest and brilliant economist, set out to evaluate it also on ethical grounds. His doctoral dissertation, written under the distinguished Joseph Schumpeter at Harvard, was later published as the book Interest and Usury (1943). In it he noted that in the light of what medieval Scholastic thinkers had written about usury, in the context of modern economic life interest charged by banks on money created by the commercial banking system may be usurious. That is because collecting interest on money arising out of the commercial bank lending process involves neither of the two main kinds of cost to the lender which the earlier medieval Schoolmen cited as justifying interest. Those were: damnum emergens (loss to the lender emerging from the loan), and lucrum cessans (gain that he ceased to receive because of the loan). The relevant deduction drawn by Dempsey was: “We may conclude from this that a Scholastic of the 17th century upon viewing the modern monetary problem would readily favor a 100% reserve plan…” (210).

Given that the economic collapse of the 1930s was ultimately triggered by speculation fed by reckless bank lending, it was not long before another Catholic priest, who entered into the discussion from the start of the Depression, declared that it was time to “drive the money changers out of the temple.” Father Charles E. Coughlin led the charge which shifted emphasis from the role of gold-based money in destabilizing the economy, to the illicit role which the bankers as “money creators” played after President Franklin Roosevelt had definitively taken us off the gold standard in 1935. The activist parish priest from Royal Oak, Michigan, was no economist, but relying on competent experts he developed a respectable level of sophistication about such matters. In 1939 he published a 188-page paperback book entitled Money: Questions and Answers. Basically it pointed in a similar direction as work by the economists at Chicago and Yale. Thus: 1) the banking system, including the Federal Reserve System which dates to 1913, should be stripped of its powers to actually create (and contract) money; 2) the federal government alone should exercise that power as assigned to it by our Constitution: “The Congress shall have the power… To Coin money, regulate the Value thereof, and of foreign Coin…” (Article I, Section 8). In addition, Article I, Section 10 expressly denies to states the power to: “ …coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts…” Technically, the federal government does coin our metallic money (coins) and establish its value until now. However coins, which ranged at one time or another from copper half-cent pieces to gold twenty dollar pieces, long ago became an ever more miniscule portion of the total money supply. Our paper money is now issued exclusively via the 12 Federal Reserve Banks. The latter are owned by the member banks which are private banking corporations run for the profit of their stockholders.

The matter of “foreign coin” is no longer an issue. It was historically conditioned in 1789 by the fact that a variety of foreign coins continued to circulate in our then cash-starved economy. For example, the prestigious Spanish silver dollar (Real) – a highly favored coin that came here mainly by trade with Spanish colonies – remained in circulation in the United States as legal tender until 1857.

Had the process of serious study and critique of our broken and antiquated monetary system continued on the course begun by economists like the Chicago group and by Irving Fisher, it is even possible that some serious reform of our failed system could have taken place. All such matters were soon put aside in the face of what seemed like the far more urgent issue: World War II.

Deliberate deficit-spending by our federal government according to the Keynesian formula was still a hotly-debated issue in the early years of the Depression. With the War, that became accepted practice even before Pearl Harbor and direct American involvement. Drafting millions of men out of the work force and into the military forces soon solved the nagging, grave unemployment problem. That dropped from the record 25% level in 1933 to 1.2% by 1944. The threat of inflation, which now loomed as the normal flow of consumer goods dried up, was kept at bay by a severe system of official wage and price controls (OPA), along with the rationing of critical materials.

After World War II ended and the basic free market mechanism was gradually restored, the problem shifted to a pattern of creeping inflation which, along with deficit federal budgets, became systemic. Following the Lyndon Johnson budget of 1969 there were no other surplus budgets until the four successive ones from 1998 through 2001 under President Clinton. These came as a surprise more than as the result of deft fiscal management. As for prices, the Consumer Price Index failed to rise in only three years during the entire post-World War II period from 1946 until the present (2013). Serious concern about the basic soundness of our monetary system virtually vanished from the scene.

More recently the step-by-step restoration of the antiquated free market economic philosophy brought with it such “jewels” as the repeal of specific features of the Banking Acts of 1933 and 1935. These had banned commercial banks, which create the bulk of our money supply by their lending activities, from also getting immersed in investment banking-type activity. That had gotten them massively involved in the stock market in 1929 with catastrophic results. Freed of the Glass-Steagall provisions and leading up to the 2008 collapse and what has now been unofficially designated as the Great Recession, commercial banks were once again in a position where they could vie with the investment bankers in all manner of inordinate real estate speculation, as well as in other fancy speculative ventures which the rank-and-file layman could scarcely comprehend.

Overall, even the Great Depression did not bring about a thorough reform of our monetary system. Still banker-based, the commercial banks remained in a position to demonstrate their basic unreliability as so often throughout our history!

American monetary history has been a tragi-comedy involving a recipe for recurrent economic disaster. Gold and silver were mined as discovered, and sold to the government at prices revised at infrequent intervals by Congress. Base metals like copper and nickel were also purchased by the U.S. Government at market prices and minted into small-denomination coins according to need, wear and tear, etc. Recurrently paper money has also been issued by the federal government. Some was backed and redeemable in gold or silver, while some was irredeemable like the United States Notes first issued during the Civil War, and their counterpart Confederate Notes issued by the South. In addition to such government-issued paper money there have been banknotes issued by nationally chartered banks: First Bank of the U.S. (1791-1811), Second Bank of the U.S. (1816-1836); and there were also National Bank Notes issued nationwide between 1863-1935 by banks with a federal charter. Along with these there had been an immense variety of bank notes issued by state-chartered banks until 1861 which, among other things, gave rise to all manner of irresponsible practices leading to the expression “wildcat banking.” In other words, throughout our history, our government has been in some sort of competition with our banks in exercising the power to issue money.

All of this proved, if nothing else, that what serves and proves acceptable as money, is money. It is ultimately a matter of convenience. Even when gold and silver coins were available, gold coins in particular were circulated less and less as more convenient and safer alternatives were developed like bank notes and demand deposits. First they were replaced successively with the various forms of paper money mentioned above. In the United States all prior forms of paper money have now been replaced by Federal Reserve Notes since 1963. In sheer volume, larger transactions are made by checks drawn on demand deposits that are eventually created by the commercial banking system.

That brings up the relevant question. How was it possible, assuming it is widely recognized at all, that bank-issued money, including most of our cash, was eventually allowed to prevail and for the most part replace money issued by the Congress of the United States? Actually the process did begin elsewhere as in European commercial hubs like Amsterdam and Stockholm during 17th century. The United States happened to come of age when all such revolutionary change in banking and finance was emerging. Once civilization reached the stage where the saying, money is what money does, came to apply, how and why did that management get to be entrusted to bankers who run corporations intended to generate profits for private investors? The answer is: by evolution and stealth!

The gradual evolution of money to its present form, where it is for the most part created by the commercial banking systems of the world, I described in my doctoral dissertation at St. Louis University (1954). That appeared later in more reader-friendly form in my first book, The Evolution of Money (1964). Unbeknownst to me, the late and widely hailed Nobel prize-winning economist, Milton Friedman, included that book among the bibliographical references in his Encyclopedia Britannica entry on Money.

Exchange – the second step in the economic process following production – is essential for civilized human existence. In the overall scheme of things, it evolved as barter where goods and services possessed in surplus are offered in kind for other goods and services in short supply. To assure a successful transaction, there has to be a coincidence of wants between the parties to the exchange. This complexity gradually led to the preferred status of certain commodities that were universally favored in respective societies, like beads, feathers, shells, cattle, whales’ teeth, wampum, etc. Among the advanced civilizations, metals, specifically the precious ones, gold and silver, eventually moved to the head of the list of commodities widely acceptable for ex­change. These occur in requisite scarcity and in an unrefined and mixed state, so that they must be assayed, weighed, and certified for use in exchange transactions. To assure the reliability of these processes, at some point rulers emerged as the main guarantors. It turned out that identical ingots – one with and one without the royal certification – developed unequal values. Certification became of more and more critical importance so that it actually added to the value and acceptability of the ingot, with its commodity value receding ever more into the background. That is how coinage emerged with the state taking on a decisive role in the evolution of money.

Notwithstanding some quibbling, there is widespread consensus that the first coin in history was the stater minted in Lydia in the 7th century B.C. It was composed of electrum – an uneven natural mix of gold and silver – which alone would seem to evoke the certification of its validity by a generally acknowledged public authority. In any case, the role of the state as guarantor in the issue of money, whether metallic or eventually even paper (like the Maryland Continental notes), was established once and for all with the emergence of coinage among the advanced civilizations of the world. But before paper money issued by various states was able to gain predominance, banks in certain European countries already began to traffic on the natural weaknesses inherent in using coins minted of precious metals.

As the world opened beyond the Mediterranean basin, the rising level of commerce required ever more money to serve its needs. Even though treasure ships from the new world brought increasing quantities of gold and silver to old Europe, the fact remained that those precious metals are of their nature soft, and the state of the metallurgical arts was crude. Hence, the coins suffered wear and tear even from normal use, let alone dishonest practices (clipping and sweating) by those who got to handle large amounts of coins in their normal business day. Besides, gold and silver coins are heavy and obvious so that they involved inconvenience and risk especially for traveling merchants. Above all, there was and always is at least a minimal need for wise management of the available monetary material; but at this point the economic science was still in a primitive state. All such circumstances led to the emergence of banking practices by the 17th century which could minimize the inconvenience and drawbacks of gold and silver coins issued by monarchs, i.e., state-issued money.

Widely regarded as the first bank which added to the money supply by violating the 100% reserve principle for deposits, was the Bank of Amsterdam (Wisselbank). Founded in Holland in 1609, its popularity grew inasmuch as customers could deposit their assorted worn and battered coins in return for credit on the Bank’s books. Having been weighed and tested by the banks, the value of such deposits then remained fixed, unlike the specie in circulation which continued to be subject to wear and tear. Thus, such deposits came to be preferred to the latter for doing business. Increasingly transfers were made on the books by oral or written order among depositors. Meanwhile the actual gold and silver specie remained secure in the bank’s vault unless and until depositors felt the need or inclination to draw it out for whatever purpose. Such occasions became less and less frequent, which is when that old devil – usury – proved to be a temptation that the bankers could not long resist. By 1657 the Wisselbank began allowing depositors to overdraw their accounts, i.e. borrow, thereby adding to the effective money supply. Soon afterward it began lending to the city of Amsterdam and investing in the Dutch East India Co. Thus the money supply was increased by the Bank’s action and the era of bank-issued money was ushered in. Because of its convenience for merchants and its consequent prestige, the Wisselbank survived several centuries until it was finally closed in 1819.

Meanwhile, the idea of a bank, where the growing variety of vulnerable state-issued gold and silver money could be safely deposited and replaced with far less vulnerable and uniform paper receipts issued by the bank, caught the attention of emerging capitalist entrepreneurs around Europe. The pioneer was one Johan Palmstruch in Stockholm, Sweden. In 1667 he persuaded the king of Sweden to charter a bank which would accept deposits of specie in return for banknotes. With the deposits remaining secure and of fixed value, the depositors could freely use the banknotes for their daily business transactions. The dominant metal in monetary use in Sweden at the time happened to be copper in the form of a square plate, involving more bulk and weight and far less value than typical gold and silver coins. It did not take much to coax merchants, among others, to deposit such cumbersome copper coins in the bank which Palmstruch persuaded the king of Sweden to charter under his management. The bank issued signed paper notes for equivalent value, and these soon replaced the cumbersome copper ingots in everyday use. Consider the switch from cash or even the checking account in the recent era to the ubiquitous credit cards (which are ultimately also, by-and-large, banker-based). The old lending-at-usury devil soon popped up here too, and Palmstruch’s Bank began issuing more notes as loans than it had actual specie on reserve. The operation collapsed in 1668, and Johan ended up in prison under a death sentence (later commuted)!

Thus ended the first experience with bank-issued money in the form of banknotes, but there were aspects of this system which were far too useful (and profitable if handled tactfully) for it to slip away into the dustbin of history. Bank-issued money was here to stay – without even a guarantee that the human race learned much from the mistakes of the past. In its favor was the continuing absence of sound principles for the issue of money by heads of state who continued to rely on chance discoveries of gold and silver. However, the rulers of the rising national states soon commenced a program when the entire range of government economic policies was geared to assuring a positive balance of trade with other nations. The latter would thus be required to settle their imbalances with payment in gold and silver. This approach included the entire period ranging between the 16th and the late 18th century. It came to be known as mercantilism; and it was the reaction to its innumerable and strict controls that eventually triggered the free market aspect of capitalism.

Meanwhile, the Wisselbank in Amsterdam and Palmstruch’s Stockholm bank marked the beginnings of the era of bank-issued money in Western civilization. The system spread to other European centers like Hamburg (1619), and to the Bank of England, chartered in 1694. Adventurous colonists soon brought modern banking practices to faraway places like New Amsterdam (New York) and Philadelphia in North America, where they caught on along with the bad habits and unsound legacy of the new capitalist era. (N.B. The age of capitalism is not to be confused with the so-called Industrial Revolution which began in the 18th century and lasts until now. Independent of the free market theory, its benefits transformed also socialist countries like the Soviet Union and China).

History since then has been replete with spectacular disasters involving the banking system – most recently the still ongoing hazardous episode now designated as the Great Recession of 2008. Among other things, that fiasco once again corroborates Irving Fisher’s dictum back in 1935 about entrusting our all-important monetary system to the “mob rule of thousands of little private mints.” These “mints,” not all of which are so “little” now, have been responsible for providing the bulk of the money supply in modern economies worldwide starting in the 17th century! All of this is not an indictment of banking and bankers as such. Banking is an ancient craft with legitimate aspects. But money being the tool of the trade makes it vulnerable. As St. Paul wrote to Timothy (1 Timothy 10) two millennia ago: “The love of money is the root of all evil.” Accordingly, Jesus Christ appears to have shown more mercy even to His tormenters on Calvary than he showed to the bankers in the precincts of the Temple! (John 2:15)

When I finished tracing the evolution of money a half century ago, there arose for me the temptation to determine what the next legitimate step in this continuing and, of late, flawed evolution might be. I came to the conclusion then, and I am persuaded even more so now: Given that the control of the supply of money is now under human control, real progress must come in arriving at a correct understanding of what the demand or legitimate need for money in a national economy is. In recent centuries that has been left largely to bankers as they gained ever more control over the supply of money. The results have ranged from dubious to catastrophic! But now, simply restoring control over the supply of money to the state where it properly belongs, but as a part of the normal annual budgetary process, could also prove to be catastrophic! An ironclad structure is needed.

Irving Fisher reached the point in 1935 where he felt the need to propose an alternative to the “mob rule of thousands of little private mints.” In the very opening chapter of his book 100% Money (1935), he opted for a government takeover of the Federal Reserve Banks – to be replaced by a Currency Commission. It would take on the function of regulating the money supply in accordance with a “certain index number of the cost of living.”

Father Charles Coughlin’s approach was similar. In his book Money: Questions and Answers (1939), he called for the establishment of a “Congressional Board of Money” that would regulate the money supply in accordance with changes in a chosen price index. He mentioned several indices including the one known now as the Consumer Price Index (CPI) that is widely used today for various purposes. Increases in the money supply (or decreases, e.g., in cases of national disaster) would take place in accordance with changes in the appropriate index to keep the price level stable.

Personally, I have reservations about using any price index as a criterion for monetary issue.

It presupposes that a disturbance in price levels must first occur before there is any change in the money supply. Other criteria for monetary issue or contraction are available, like the population or the size of the work force, or its obverse side, the national output (GDP). That would also reflect the nexus between the human factor of production and the national output.

As Adam Smith put it in the opening sentence of his Wealth of Nations: “The annual labor of every nation is the fund which originally supplies it with all the necessaries and conveniences…” Actually, on that supremely important economic principle Smith was in agreement with two other very strange bedfellows in the unfolding of economic thought: Karl Marx, and the Jesuit economist Heinrich Pesch (d. 1926).

Meanwhile, I owe thanks to the recently elected Pope Francis for summing up the entire complex matter crisply. On May 15, 2013, he said: “Money has to serve, not to rule!”


Rupert Ederer is a retired professor of economics. He is 89.

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