What is money? To put it simply, money is the medium of exchange that a society has selected. However, the money system of today is very complicated. The money of the United States has changed its form several times since its birth. It is now a system of credit and interest rates that are somewhat difficult to understand. Unfortunately, most people don’t spend a lot of their time thinking about it.
The money supply of the United States is currently regulated by an organization called the Federal Reserve, or simply “The Fed”. The Federal Reserve is the bank of banks and the only bank of that the Federal Government uses. It was created in 1913 by the Federal Reserve Act and began operating in 1914. The purpose was to regulate the money supply, stabilize the economy, and create a uniform standard of currency throughout the states as there were many different kinds of currencies floating about before The Fed’s inception. Note that the Federal Reserve is not a branch of the government. It operates as a private company that is meant to sustain itself. It is referred to by many as a “quasi government” organization and is run by a board of directors that are handpicked by the President of the United States. There were many events in the history of the United States that led up to the creation of the Federal Reserve System.
After the original thirteen Colonies won their victory over British rule in the War for Independence, The Articles of the Confederation were drafted and then ratified in 1777. The Articles did not specify a standard of money that was to be used in the new country. The decision to determine how the money supply was to operate was to be left up to Congress. At first, the money issued by Congress at that time was backed by foreign money from European countries like France, Spain, and Holland. Most of the European monies however were notes of credit, and the physical coinage was not in abundance on the Western Continent at that time. Congress was forced to print money to pay off the debts of the colonies for the Revolutionary War and the new country experienced hyperinflation. With the onset of hyperinflation hard economic times soon followed.
The European countries that issued these notes of credit to the Colonies called in the debt shortly after the war and demanded payment in gold or silver. The debt was passed on to the people of the new United States in the form of a heavy tax burden. When these taxes could not be paid many people were thrown into debtor’s prison and had their property confiscated. This is what led to Shay’s Rebellion in 1786. Although the rebellion was quelled, it caused the Founding Fathers to rethink the Articles of Confederation.
Shortly after Shay’s Rebellion a new Constitution of the United States was authored and ratified in 1787. It stated that the legal tender of the United States was to be nothing but gold and silver: “No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; etc…”[1] Paper currencies that have been printed were backed by those two commodities in the national treasury. Clearly the Founding Fathers thought it would be better to have a hard currency that was backed by a precious metal than nothing at all.
Congress had the power to define weights and standards with the new Constitution[2], and defined what an American dollar was to be. Precious metals were always weighed in Troy Ounces. A troy ounce is 480 grains (31.1 grams), which is a little heavier than the avoirdupois (standard) ounce which is measured at 437.5 grains (28.35 grams). In 1972 the dollar was defined as 24.75 grains of gold and also in 1794 the dollar was defined as 374.4 grains of silver, but was changed to 371.25 in 1795. The change was believed to make the silver to gold ratio an even 15:1. Later the definition of the dollar was changed again in 1837 to be 25.8 grains of 9/10 fine gold to make the ratio approximately 1 gold coin to 20 silver coins.
Money existed this way until 1861 when the Civil War between the states broke out. Before the Civil War the paper money of the United States that was redeemable in gold or silver, but were not interest bearing. In order to finance the Civil War the Federal Government printed non-interest bearing notes call Demand Notes, or as they were nicknamed, Greenbacks. Even though the notes were redeemable, they were more printed than there was gold available. This caused the dollar to suffer from printing press inflation. After the war was over, deflation occurred and the US dollar’s value stabilized.
Shortly into the 20th Century, the Federal Reserve Act was signed into law. The standard of gold remained unchanged until April 5th 1933. On that day executive order 6102 was signed into law, the use of gold was suspended as currency, the possession of gold became illegal, and the property (gold) of individuals and corporation was confiscated. At this point in American history, it is known that people attempted to hide their gold throughout the country. There are gold treasures still hidden today. Shortly after the signing of this infamous executive order, in January of 1934 the Gold Reserve Act was passed. Citizens could still not trade physical gold, but the bullion was stored by the US treasury and they issued gold certificates against the gold that they stored. Even though the certificates were backed by this gold, no one could redeem the certificates for the physical gold coinage. The value of the American dollar was redefined to 15.715 grains fixing it to a price of $35 an ounce.
The United States changed its currency to a complete fiat currency in 1971. Author Roger A. Arnold states in one of his textbooks, “It is a myth that paper money has to be backed by some commodity (e.g., gold) before it can have value. Today, our money is not backed by gold. Our money has value because of its general acceptability.”[3] That is absolutely a true statement. Money does not have to be backed by gold. But the question that should be asked is, “should our money be backed by gold?”
Historically, fiat currency has resulted in inflation. Some economists would argue that inflation is a good thing. It would allow people to pay off their debts faster, be easier to increase the money supply with a growing population, encourage foreign investment, and encourage exports. It would be easier for the Federal Reserve to extend credit to the Federal Government and other banks which would increase the money supply and in turn encourage economic growth. After all, many economists argue that the value of gold itself is arbitrary and not intrinsic anyway. We assign value to gold; therefore we can assign value to fiat currency.
While this reasoning does make sense on the surface and is able to pacify most people questioning the practice, a fiat currency can never function as well as a commodity based (hard) currency. The largest difference between the fiat currency and the commodity based currency is that the fiat currency comes from the government (or a private cartel of bankers as is the current situation in the United States) and gives them a lot of power over the economy. As opposed to the commodity based currency that comes from the market and gives most of the control of the economy to the people. Since the current Federal Reserve Note is credit extended to the person currently in possession of it, the consumer does not own their own money, it is owned by the Federal Reserve. The fact that the money is no longer the property of the consumer is what takes the economic power out of the hands of the market and places it in the hands of a centralized power.
The argument that inflation is a good thing since it allows people to pay off their debts faster can easily be refuted. It is only good for the lender if their income increases at the same or better rate than that of inflation and if the loan was taken out with a low fixed interest rate. The people who benefit most from this model are the people who have purchased property and are paying off a large mortgage, farmers who have purchased and taken out large loans for their farm machinery, or businesses that are paying off capital equipment. The people who rent or have little to no debt do not get to enjoy this benefit. This argument also does not take into consideration those who are retired and living on a fixed income. The value of their retirement savings decreases quickly which will decrease their standard in living, increase their stress, and will result in a loss of enjoyment of life. There is evidence that this is currently happening in the United States as the rate of senior citizens that have recently declared bankruptcy has increased exponentially.
While a fiat system would make it easier to increase the money supply for a growing population, it becomes too easy to overestimate the amount to create and cause undesirable hyperinflation. Speculation becomes a major part of planning an economy, as no one is capable of predicting the future. Under the usage of a hard currency, the money supply can also be increased with mining operations of precious metals. Not only would it keep inflation to a minimum, it would create and maintain jobs in many different parts of the country and in different industries in order to keep up with the demand of society. Increasing the money supply can also be accomplished by redefining the dollar. This has been done several times throughout American history.
Foreign investment in American business may decrease as a result of returning to a hard currency, but this not necessarily a bad thing. It would mean the United States would no longer have to worry about other countries abandoning the dollar. Trade would be easier with other countries as our currency would spend the same everywhere and it would not matter what the credibility of the United States government was at any given time. It would also return America to a state of independence it once had which is key in maintaining a good foundation in the emerging Global Economy.
Many citizens of the United States believe that the Gold Standard is an outdated form of currency. That it had its place in history, is not needed, and never will return. Many younger Americans living in the United States have known nothing but the fiat currency that has been provided to them by the Federal Reserve. Many of them believe that it works just fine and always will work. This is just an example that the lessons of history were not taught to them. The switch over from a hard currency to a fiat currency devalues a nation’s currency until the currency becomes worthless. Unfortunately too many nations simply redefine their fiat currency, such as the case with Israel issuing the New Israeli Shekel. This is only a temporary solution to the permanent problem of the fiat system.
All of the great civilizations of the world were at their peak when they used a precious metal as their standard of currency. Records can be traced that show that the Roman Empire didn’t start collapsing financially until they took the gold and silver out of their coins. The same is with many European countries. When Spain had issued the Doubloon during her peak in power, it became a standard coin in many countries throughout the world. Whenever countries devalue their currency by taking the hard backing out of it economies crumble. This is one of the ways in which Adolf Hitler was able to rise to power in Germany after the First World War. In order to bring Germany once again into a powerful position, the new leadership issued the Reichsmark. The 5 Reichsmark coin was 90% silver and the smaller 2 Reichsmark coin consisted of 62.5% silver.[4]
As is our money system today, the Federal Reserve creates money out of thin air and loans it to banks and the Federal Government with interest. This will result in hyperinflation (also known as printing press inflation) as was seen throughout American history as the precious metal backing was removed from the money supply. While money can still experience inflation when it is backed by a precious metal, historically the inflation balanced itself out rather quickly. The backing in the United States did not exist under the Article of Confederation. After experimenting with the fiat currency system, the Founding Fathers of the United States made it a point to state that gold and silver was to be the new money this country. The Federal Government also suspended or modified precious metal backing during most wars prior to World War II.[5] The following graph (from http://en.wikipedia.org/wiki/Gold_Standard, 8/11/2008) shows that the value of the American Dollar was always at its highest when pegged to a precious metal and lowest when it was not. It dipped the most when the dollar was removed from its physical backing until 1933 when the gold standard was officially done away with:
Notice on the graph above that the value of the dollar fell sharply during major wars that the US was involved in due to printing press inflation. These include The War of 1812, the Spanish American War, and the United States Civil War. Also notice that after the precious metal backing was reinstated was followed by a period of dramatic increase in the value of the American Dollar along with economic growth. At right around the year 1900 the value was right on par with the value at 1776.
At one point in history the American Dollar was the most desirable currency on the Global Market. Many nations had their currencies pegged to the United States dollar. Since the fall of the gold standard in 1933, the US dollar has lost almost all of its purchasing power on the global market being surpassed by currencies such as the Euro, the British Pound, and even the Canadian dollar at one point. Many countries that had their currencies pegged to the dollar have abandoned it in favor of the Euro.
A commodity based currency would be more stable on the growing Global Economy. As Roger A. Arnold states in his textbook titled macroeconomics, gold is the same price in England as it is in the United States. This means that it would be easy to spend anywhere on the global market, it does not matter who’s face is minted on the coin (or printed on the warehouse receipt). In today’s Global Economy, the credibility of each government needs to be factored in the conversion rate. With the return to the gold standard, the true value of the United States dollar will return and it might even regain its place as the world’s main currency. If it does not happen, then the economic empire that America had established will only be remembered in the history books.
Some modern economists would argue that since gold is a limited resource, we would eventually run out. Gold is not actually consumed permanently. It does have industrial, artistic, and electronic uses but can be recovered. Many companies today make their profits by extracting the precious metals from electronic circuitry after it can no longer be used. However if the gold supply could not be increased to keep up with the growing population and economy, the market would simply select another medium of exchange. Silver has always been competing with gold. Since 2001 silver has more than tripled in value, and many speculators believe that it may someday outperform gold in terms of value. Now with the increase of the scarcity of copper due to industrialization of many nations, it has also appeared on the market as an investment metal. Other metals which currently act as investment metals such as the platinum group metals and rhenium may appear on the market as a form of currency should the increase in the gold supply become unsustainable.
Since hard currencies hold their value while fiat ones do not, one can clearly see that the American dollar has lost about 96% of its purchasing power since the start of the Unites States in 1776. Holding what is called the dollar today against the gold standard only has a value of $0.04. One can also see that the same amount of goods can be purchased today with one ounce of gold that could be purchase with that same ounce a hundred years ago. Hard currencies have the ability to protect wealth over the long term while the Federal Reserve note is only doomed to be depreciated with the passage of more time. The Federal Reserve Note printed in 1975 could buy much more back in 1975 than it could now.
The issue is not a question of whether or not there should be a centralized bank such as the Federal Reserve, but rather it is whether or not there should actually be something of value in those reserves. Not only should there be something of value in those reserves, the physical gold or silver coinage should be completely redeemable to the consumer. While the American Dollar may still have some value on the Global Market today, it might only be a matter of time before other countries decide that there is no reason to accept credit from the American Government or banking system. It’s not a matter of if but when the Federal Reserve Note loses its acceptability on the Global Market. While money does not have to be backed by a precious metal, it may be in the best interest of the United States if it were.
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