[R-G] [BillTottenWeblog] How Lincoln Might Fix Our Economic Mess

[Bill Totten]

by Richard Striner

History News Network (December 01 2008)


As America grapples with the worst economic chain-reaction since 1929 -
and as President-Elect Obama takes time to consider more closely the
methods of Abraham Lincoln - it is time to reconsider a monetary method
that Lincoln and the Civil War Republicans used, a monetary method that
America's leading economists attempted to revive in the 1930s.  It's a
method that could work right now, but with a critical revision to adapt
it to the methods and techniques of the Federal Reserve.

Extortionate bank interest rates caused Lincoln and his fellow
Republicans to think more creatively about finance.  They decided to
supplement the revenue from taxes and bonds with direct creation of
money - the Civil War greenbacks - via the Legal Tender Act of 1862.
Though many recommended the continuation of the method in subsequent
decades - the Greenback Party in the 1870s, the National Farmers'
Alliance in the 1880s, "Coxey's Army" of the unemployed in 1894, the
contemporaneous Populist Party, and the Democratic Congress in 1933,
which included in the act that created the Agricultural Adjustment
Administration (AAA) presidential authority to print and issue
greenbacks - the experiment has never been repeated.  Private financial
interests joined at the hip with political insiders have thwarted the
idea at every turn.

The conventional wisdom would have us believe that the use of what some
call "printing press money" which the government creates out of nothing
and spends directly into use, leads to ruinous hyperinflation.  The
usual exhibit is Confederate money, which depreciated so disastrously
that it was worthless.  At its worst, the rate of Confederate inflation
was 9,000 percent.  But consider in comparison the rate of inflation in
the Union:  eighty percent.  That's of course double-digit inflation,
but the difference reveals a very interesting fact:  a wide variety of
economic factors can mitigate the side-effects of governmental money
creation.  And since the Civil War, new institutions have developed,
like the Federal Reserve, that are well equipped to fight inflation.

A general ignorance about money obscures the fact that "printing press
money" is created right now by the Federal Reserve.  In a 1939
guidebook, The Federal Reserve System: Its Purposes and Functions,
published by "the Fed" and written principally by economic historian
Bray Hammond, this pithy revelation appears:  "Federal Reserve Bank
Credit ... does not consist of funds that the Reserve authorities 'get'
somewhere in order to lend, but constitutes funds that they are
empowered to create".  This stunning revelation was deleted from
subsequent editions of the volume.

How can such a thing be possible?  In the history of money and banking,
it's a long and complicated story.  But the gist of it is this:  over
time, the financial term "credit" evolved from the legal/economic
denotation of a "promise to pay" to the functional/dynamic equivalent of
actual payment.  That's how our money supply can expand at any time
through the lending activities of banks.  Want proof?  Grab an Econ 101
textbook and look up "fractional reserve banking".

Americans in general know absolutely nothing of this; even presidents
have been in the dark.  The financial journalist William Greider once
observed that the process of money creation is "a powerful mystery to
most citizens".  In his book Secrets of the Temple:  How the Federal
Reserve Runs the Country (1989), he quoted the head of the Federal
Reserve Bank of New York as follows:  "No President really understands
these things".

In the Great Depression of the 1930s, America's leading economists tried
to explain it all to FDR and the American people.  They urged Congress
itself to supplant both the Federal Reserve and its member banks as the
fundamental source of new money.  In 1934, John R Commons, co-founder in
the 1880s of the American Economic Association, wrote that "in order to
create the consumer demand, on which business depends for sales, the
government itself must create ... new money and go completely over the
head of the entire banking system by paying it out directly to the
unemployed, either as relief or for construction of public works".
Henry C Simons of the University of Chicago condemned "the usurpation by
private institutions (deposit banks) of the basic state function of
providing the medium of circulation".  Irving Fisher of Yale wrote that
"the government should take away from banks all control over money
creation".  In recent years, such maverick economists as John H Hotson
and William F Hixson have continued this tradition.

But the chances of essentially "toppling" the Federal Reserve in a
frightening economic environment such as this one are nil.  And rightly
so.  Even in normal times, the massed forces of Wall Street would make
the idea truly dead on arrival in Washington.

But here's a different idea.  Let Congress create new money, but this
time do it in a way that would employ all the tools of the Federal
Reserve and its member banks to counteract inflationary pressures.
Here's the recipe:  Congress creates the new money ("out of nothing"),
then spends it through direct electronic deposit into the bank accounts
of government employees and vendors.  Once the government money has been
spent into the banks, it would be (1) instantly convertible to cash
through the methods of the Federal Reserve, and (2) subject to all the
major monetary tools through which the "Fed" can now counteract
inflation.  These include not only the obvious tool of raising interest
rates - inadvisable now when the economy needs a great stimulus - but
also the method of raising the "reserve requirements" as Paul Volcker
did in the eighties.  As the bank deposits increased - as new government
money poured into the banks, thus expanding the money supply - the Fed
could require all the member banks to put equivalent funds "on reserve"
off-limits for lending.  And this could nip inflation in the bud.

Think it over:  the result could be essentially a "wash" an almost
perfect offset.  As the banks received the new deposits (thus expanding
their capacity to lend) their reserves would be adjusted accordingly.
This would not necessarily inhibit the private-sector market.  It could
do the reverse:  with government spending increased, more Americans
would now have the cash to be vigorous customers again.  Our "economic
pie" would get bigger.

Meanwhile, our government could spend many hundreds of billions on
public necessities without higher taxes, without more deficit spending,
and without any serious inflation.

It's time for this idea to be discussed in a national debate.  Desperate
times call for innovative measures.

_____

Mr. Striner is Professor of History at Washington College and the author
of Father Abraham: Lincoln's Relentless Struggle to End Slavery (Oxford,
2006). He has written on economic issues for the Washington Post.

http://hnn.us/articles/57568.html

TO POST A COMMENT, OR TO READ COMMENTS POSTED BY OTHERS, please click
on the word "comment" highlighted at the end of the version of this
essay posted at http://billtotten.blogspot.com/