Aug

29

Now that Shark Week on the Discovery Channel is fading from memory, it seems appropriately bad timing to revive the question that drives many DailySpecs to reach for their academic harpoons.

For those of you unfamiliar with the history of this argument, a brief summary:

The authors of the United States Constitution and the people who voted for its approval thought that money's special purpose was to serve as a final unit of account - i.e. the stuff that people use for pricing their own and other people's assets and liabilities - under the "law"- i.e. the courts and the government would recognize the unit of account as legal tender. The authors of the Constitution and those who ratified it were also wise enough to know that the greatest risk to their new Republic was to allow anyone - private or public - the privilege of debasing the country's legal tender unit of account. If Congress or the State legislatures had the power to debase the currency, they would most certainly do just that. The war veterans who were the majority at the Constitutional Convention had seen the Revolutionary War come close to being lost because Congress and the states had literally written more checks (actually, printed more notes) than their credit could support. That would not be allowed to happen again.

The Founders' solution was wonderfully direct and subtle. The states would retain the power to charter banks but they would surrender the authority to legislate what would be the legal tender unit of account. Only Congress would have the power to "coin Money". Congress, on the other hand, would have its authority over the country's legal tender unit of account limited to regulating the weight and measure of domestic and foreign gold and silver coin. It would not have the authority to make its own IOUs into money. In the periods when the Constitutional gold standard was observed by Congress (1789-1862;1869-1914), the Federal government was required to pay all its bills, including redemption of its debt, in specie at the weight and measure that defined the dollar as a legal tender unit of account. Even now, a century after the Congress, the President and the Supreme Court all decided that the Constitution could be safely ignored in the name of the War to End All Wars, our laws still observe the restriction on the states' ability to define money. The U.S. dollar is now paper, not gold; but only Congress can authorize its printing. The Coinage Act of 1965, specifically Section 31 U.S.C. 5103 ("Legal tender") limits the country's unit of account to "United States coins and currency" and affirms that they are "legal tender for all debts, public charges, taxes, and dues."

What seems to confuse nearly everyone is the fact that, from its very beginning, the country did not do business in money but in credit. That part of our national legacy remains unchanged; and it is so elemental a part of the American political economy that even the Federal Reserve finds it hard to explain that we are all - sharks and prey both - swimming in a credit sea. When asked why the Federal and state governments often refuse to accept cash but will take payment by checks, money orders, and credit cards - none of which are, under our law, "United States coins and currency", the Fed could only answer the question by referring to the very language of the Coinage Act that raises the question in the first place.

Americans have always dealt in credit, not cash. Even the opponents of the authorization of a national bank accepted, as obvious, the right of banks to issue notes that would be broadly accepted as a means of payment. The First and Second banks of the United States and the State chartered banks were all authorized to issue notes, and state laws even allowed state bank notes to be considered legally sufficient payment for state taxes. But, no one believed that bank notes themselves were to be considered actual money. That truth was reflected in the pricing for goods and services. As Sumner notes in his History of American Currency, while pricing would use a consistent unit of account, the prices themselves were determined by what exactly was being paid. So, in Connecticut, under the example Sumner took from Felt's study of colonial currency, a sixpenny knife cost in 12 pence in pay but only 6 pence in money. ''Pay " was the state issued currency price (Connecticut, Massachusetts, Pennsylvania and other colonies all tried at various times to issue paper currency to "save" (sic) their precious metals); "money" was Spanish or New England coin, (with) only wampum, no paper, accepted for any change (fractions of a penny). To deal with the complications of government price fixing (colonial governors were always trying to deal with shortages by establishing official prices), people even dealt in "pay as money"; the official price would be acknowledged but the government's paper money would be discounted by 1/3rd from the nominal government exchange rate.

By dealing in credit Americans had precisely what the Federal Reserve Act promised to provide - a flexible and adaptable means of payment. What they also had was the assurance that the government itself could never risk its own credit because it would always pay up in cash. A state legislature might - foolishly - adopt laws that recognized the state's own bank notes (but not those issued by out-of-state banks or local private banks) as sufficient payment; but Federal customs and excise taxes were only payable in gold. It was precisely the desire of South Carolina to avoid this restriction that led to the first of the many nullification crises. Everyone applauded sound money; but no one liked using it to pay their out-of-town debts. Sumner explains it beautifully: "The colonists began, soon after the settlement of Massachusetts Bay, to use a barter currency, ostensibly because they had not money enough: really because they wanted to spare the world's currency to purchase real capital, which was their true need. The currency history of this country has been nothing but a repetition of this down to the present hour. It has always been claimed that a new country must be drained of the precious metals, or that it could not afford so expensive a medium. The new country really needs capital in all forms. The only question is whether, being poor and unable to get all that it wants, it can better afford to do without foreign commodities or without Specie currency. No sound economist can hesitate how to decide this question. The losses occasioned by a bad currency far exceed the gains from imported commodities….. Credit, in its legitimate forms, is priceless to a new community, but when used in illegitimate forms, as in a pure credit currency, or in a currency into which credit enters in an indefinable element, it makes true credit impossible."

What is remarkable about American history is that, thanks to the leadership of Sumner and Sherman (John, not Cump) and - most of all - President Grant, the United States chose, after the Civil War, to restore its Specie currency and to honor its greenback IOUs in gold. What is equally remarkable is that entire history - and its remarkable successes - are not entirely forgotten. Resumption forced Congress, the Treasury and the banks to all have notes constantly discounted against "money" prices by the market. The result was something that no modern economist understands; neither the government nor Wall Street ran the country. Wall Street could "panic" and repeatedly did; but enterprise did not suffer. The bank crises of the 19th century were severe, but they lasted for months, not years; and there had no lasting effects on the country's growth and accumulation of wealth. The investors and depositors in untrustworthy banks lost their funds; but the trustworthy banks were able to expand. In the absence of a central bank, failures were not socialized; in the absence of fiat currency, the money "supply" (sic) was not an issue. The gold did not evaporate, and entrepreneurs and laborers were free to take their savings and invest them in new, credit-worthy ventures. J.P. Morgan became so powerful, even though he was, as Rockefeller observed, a man whose personal fortune was comparatively small, precisely because Morgan's bank notes always sold at par. In times when other banks were caught short, Morgan's deposits would swell. That was - and is - the beauty of the Constitutional gold standard; it allowed the market to set the relative prices of money and credit by never confusing the two.


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