by Jarl Jensen
In 1913, the Federal Reserve Act created twelve branches and made them storehouses for regional banks credit. Early policy lowered the reserve requirements of the national banks to approximately 1/3rd of total net deposits. Similar laws followed suit, and ten years later a fractional gold reserve system was in full swing.
Pure Gold Standard vs. Fractional Reserve
Before the Federal Reserve, banks were only able to lend out as much currency as they had gold in storage. If the bank had 100 million USD in gold on the premises, they could only lend out that much to customers. Since gold fixed at $20.67, banks needed lots of gold to offer flexible lending rates to customers.
The problem is, of course, that gold is a finite entity. The bankers argued that there was not enough to go around, so the Federal Reserve instituted lower reserve requirements.
How does fractional banking work?
In a fractional reserve banking system, only a percentage of bank deposits need to be made available for withdrawal from a branch. For example, banks with assets less than $110.2 million are obliged to keep a 3% reserve requirement, so that the rest can be invested in Federal Reserve bonds.
The purpose of a fractional system is to free up capital for use in the economy. And it did just that. Net deposits of national banks rose from $7.5 billion in 1914 to $32 billion in 1931 – a 300% increase in lending over 15 years. What the bankers did not realize was that flooding the market with credit supply would cause inflation.
The impact of the fractional gold reserve meant five key trends leading up to the Great Depression:
Initially, lower interest rates were possible because paper money was being produced. Small businesses and individuals took out loans because the interest rates were low.
Over time, as loans were not paid back on time, interest rates were raised in 1928.
Meanwhile, the price of goods and services rose in tandem with the credit supply. As Henry Hazlitt put it: “twice the credit does not do twice the work!”
Banks kept on lending beyond their means to try and stimulate growth.
Ultimately, when borrowers came flooding into Wall Street to exchange paper money for gold in 1929, most banks had nothing to offer. Just when owning gold could have made all the difference for average Americans, the banks could not provide it.
True Wealth Burned to the Ground
One unusual event and particularly abhorrent was ‘Black Wall Street’ of 1921. An all-black neighborhood had found the secret to true prosperity. They did not need the partial credit of the federal reserve nor did they get access to it. They kept their hard-earned money in their community using the same dollars over and over again to do work for each other. By 1921 the Black Wall Street community of Tulsa Oklahoma was so wealthy that the neighboring white people burned it to the ground and even bombed it from planes. Racially isolated communities were then torn apart all over the country in many cases under the guise of desegregation. Thus, leaving the whole country dependent on the hollow practices of a debt-driven economy. Low and behold 100 years later it’s hard to get through life without debt because that’s how the bankers grow by lending us money. These communities would have been shimmering beacons of hope through the great depression, and one has to wonder if there was more than just racism involved. After all, bombing 32 city blocks from the air in 1921, let alone today, is quite an undertaking, one that might require debt financing.
A New System is Needed
The lesson to be learned from the Great Depression is that Federal Reserve policy is ill-suited to meet the needs of average Americans. It has contributed to the Great Depression, Black Wall Street and the increasing cost of living ever since. An unbiased look at the evidence indicates a new economic system is needed – one that changes the inputs and optimizes the outputs for all.
How German Manipulation of Currency Lead to Global Monetary Rules After WWII
When Germany suspended the gold standard to help fund the costs of WWI, they set in motion a series of economic dominoes that concluded with a grand finale: a system of global monetary rules and standards.
While hindsight is always 20/20, it is helpful to look back at the causes for Germany’s dire economic situation in the 1910s to see how one catastrophic mistake lead to another. The result, the end of the gold standard and a monetary system built on predatory lending has only deepened our persistent economic malaise.
The German Situation in the 1910s
The German economy in the 1910s was, in some ways, optimized for war. Realizing they needed to match the British by spending more, the German government decided to fund the war by borrowing money rather than implement an income tax. It would prove to be a catastrophic mistake.
Price Manipulation and What It Meant
The German parliament decided to suspend the gold standard (the convertibility of the Deutsche mark to a stable gold price), to increase borrowing potential.
Unfettered by the rigid gold price standards, the Deutsche mark began to lose value to the US dollar. Of course, the government was not worried about currency devaluation because they planned to win the war and make back all of their debt through heavy taxation of the Allies.
The Global Impact of Price Manipulation
Germany was not the only country to suspend the gold standard to fund government spending. However, the timing of the decision contributed to a global distrust of the gold standard and the emergence of inflationary pressure across the board. The British decided to impose strict exchange controls on gold – and price levels doubled. In France, price levels tripled. In Italy, they quadrupled. In America, although relatively disconnected from the inflationary pressures in Europe, price levels doubled in the years following WW1.
The War and Its Aftermath
As we know, the Germans lost the war. In the Treaty of Versailles, they were forced to pay substantial reparation bills to cover the cost of war for the Allies. Combined with soaring domestic debt and a shift away from the gold standard, the Deutsche mark slowly became more and more worthless. Hyperinflation set in, and the conditions were set for a radical ideology like Adolf Hitler to captivate the hearts and minds of a desperate population.
The unfortunate truth is that the horrors of the Holocaust, WWII, and the implementation of a global monetary system were all triggered by the German political decision to go off the gold standard. Germany effectively borrowed money from other countries and repaid their debts with their valueless Deutsche Mark. By some calculations Germany actually made money from war reparations of WWI. It is no wonder the American and English governments were not going to allow that to happen again after WWII.
The Necessity for Global Monetary Rules
Germany instigated a global migration away from the gold standard in the 1910s. One by one, the strength of domestic currencies across Europe began to weaken, and inflation started to creep in. The widespread economic instability of the 1920s and 30s produced the Great Depression and a collection of vicious dictators in Europe who brought human evil to a whole new low.
In an effort to never allow the rise of these vicious dictators again, an international monetary system was put in place at Bretton Woods. The formation of the IMF and the World Bank might seem virtuous, but the main purpose was to prevent the rise of powerful dictatorships like Nazi Germany. Currencies were pegged to the dollar. Third world countries were given loans in dollars that had to be repaid in dollars. These rules economically paralyzed third world countries with American dollar debt. And to this day, third world countries remain oppressed by the Bretton Woods agreement, the IMF and the World Bank. Behind the logic is fear of another Nazi Germany rising from the ashes like the events that unfolded after WWI.
Conclusion
Given this backdrop, it was inevitable that economic leaders would create a set of monetary policies to oversee global fiscal control. The IMF and World Bank are not the only impediments to growth but their purpose is not as virtuous as one might think after all they were created to es
tablish global economic domination. However, it is a shame that they continuously plunge countries into further debt with strict conditionality and unrealistic policies. You would think global leaders would have learned from the mistakes of the first half of the 20th century and created a more functional world economic order, right? It’s high time for a new vision, a novel set of policies, a fresh outlook on fiscal policy.
The Bretton Woods Agreement and the New Global Order
The Bretton Woods Agreement was a landmark piece of financial legislation passed in the fallout of WWII. Then a new world order was created around the strength of the USD and the short-term gains of a debt-based economy. Although doomed to failure, it did allow American interests to take center stage in a new, globalized financial system.
The Bretton Woods Agreement
The Bretton Woods Agreement was developed in 1944 when delegates from 44 countries came together to discuss how competitive devaluation could be discouraged in favor of stable economic growth. Harry Dexter White was the chief international economist for the Treasury Department. He spearheaded a plan that included the creation of:
• The International Monetary Fund (IMF) – Tasked with monitoring exchange rates and lending reserve currencies to nations in need of a boost.
• The World Bank – Designed to offer reasonable
loans to countries looking to rebuild after WWII.
• The US dollar as the global currency. Nations would now redeem their money in US dollars rather than gold. From this point onward, the USD became most sought-after currency in global markets.
• A fixed exchange rate system. Member countries agreed to maintain fixed exchange rates between the US dollar (in reserve) and their currency. It was intended to prevent devaluation wars that only brought inflation and instability. Operating on a fixed exchange rate meant countries promised to buy up their money in foreign markets when the value became too weak.
WWII and the Destruction of the Gold Standard
From a monetary perspective, the period between 1920 and 1944 was defined by migration away from the gold standard. Countries needed to print money to fund military efforts, which they did without considering the long-term consequences.
The shift away from a fixed gold standard in the 1910s produced WWI and hyperinflation across most of Europe. An increase in the supply of money submerged demand and lead to a general devaluation of domestic currency – no more evident than in Germany in the early 1920s.
After WWII, the situation had only gotten worse. Most European countries were in severe debt and needed a way out. It became clear that the rigid structure of the gold standard did not offer them enough flexibility in navigating through tough economic situations. It was part of the justification for a new system. Under the Bretton Woods Agreement, nations had the flexibility of trading in US dollars, which acted as a loose standard for countries to compare.
The IMF and American Hegemony
If the US dollar was the skeleton of the Bretton Woods Plan, the IMF acted as the backbone. Countries needed access to a quasi-central bank that could bail them out when their currency began to spiral downwards, and the IMF provided such a resource. If nations could not borrow from the IMF, they would have to hike interest rates or implement trade barriers – just the kind of destabilizing behavior global leaders wanted to avoid. Borrowing from the IMF seemed like a better alternative, though it did lock many countries into strict debt repayment plans they could never meet.
The Bretton Woods Agreement massacred the lively hoods of the American worker and the economies of third world countries
The Bretton Woods agreement helped prevent the rise of another Nazi Germany, but it also stunted the growth of the rest of the world and unintentionally put a stray jacket on the American worker. The dominance of the American dollar after becoming the default currency in trade as an alternative to gold reserves means that debts made in dollars to third world countries dominate those economies. These dollar-based debts prevent those economies from maturing just like the Bretton Woods plan had originally intended. Germany and Japan had the intellectually capacity after WWII to start making cars for the American economy which allowed them to eventually pay off their debts and war reparations, however they had to give up almost all military and self-defense expenditures to do so. However, for most of Africa, South America and Asia their economies were not in a position to do the same and so they have been constrained economically to a miserable existence.
The American middle-class and working class has also been severely undermined by the Bretton Woods and new global order. The American Dollar dominance has made work done by American’s very expensive and uncompetitive. Today, America’s national debt is the main tool used by foreign nations to prop up the American dollar, again making the American worker uncompetitive.
Understanding how international economics works is critical to understanding why trade war is not the issue, it’s the government’s willingness to add to our national debt for the sake of lower tax rates for the wealthy. The lives of the middle and working class have been additionally exacerbated by the continued rise in the cost of living caused by FIAT monetary policy which has allowed for unlimited mortgaging of homes raising the cost of housing.
The combined lethality of British Colonialism and Bretton Woods.
Millions of children and people die every year because of Bretton Woods. Bretton Woods effectively made all economies debt based. This means that in order to print money to service a debt, you need an asset to borrow against. Britain Colonized and exported all the valuable assets back to England of most third world countries around the world, all but one country on the continent of Africa. After Bretton Woods these countries were offered loans in American Dollars to ‘start’ there economies but it did just the opposite. After spending the initial loan on some American contractors, they were left with debt payments. England had already taken everything of value, so they could not print money since there was no asset to borrow against. If the government chose to printed money and just spent it they were met with hyperinflation like Zimbabwe, Argentina and Venezuela. In order to stop hyperinflation, they can borrow more money from the IMF which only locks them even further into oppression. In essence, these countries are oppressed, and their people are literally dying by the millions every year.
Conclusion
Official Bretton Woods policy lasted until 1973 when President Nixon de-linked the value of USD to the price of gold. Despite moving to a floating system, the IMF remains an essential player in global fiscal policy. By extending loans to dysfunctional nations, the IMF is successfully spreading the claws of American business interests into foreign economies through the one-size-fits-all system we know best: deficit spending. Albeit, there must be a better way to raise the material well-being of global nations than to plunge them into debt like America is.
America’s Addiction to Debt
Back-to-back administrations in the late 70s and 80s were unable to prevent the specter of stagflation from taking over the economy. Although every macroeconomic policy under the sun was attempted, and both Carter and Reagan were undermined by a sea change in America’s debt structure, the increasing sale of national debt to foreign governments to finance further deficit spending.
What is stagflation?
Stagflation is both stagnant economic growth and inflationary pressure (when the money supply artificially increases the value of one unit of currency). It is an unusual phenomenon because most weak economies do not produce enough growth to cause dangerous inflation.
The Cause of Stagflation
Stagflation occurs when the government expands monetary supply while the jobs market is weak. The money supply can be expanded by the printing of money or the sale of national debt, especially when there is no limit to the amount of money that can be printed. As it happened, automation was taking hold of the economy as early as the 1950’s. And the US government simultaneously sold massive amounts of debt to forei
gn entities.
When a foreign government buys America’s Treasury Bonds, they are essentially paying for America’s government spending, so that they can be paid back later with interest. This artificially empowers the government to spend money that the economy did not earn. America’s economy at the time was not structured to take advantage of the strong dollar created by foreign countries buying America’s national debt.
The Carter Administration
The Carter administration was, in many ways, the scape goat for stagflation in the later 1970s. Thanks to easy money policies of the Fed and the doubling of crude oil prices in 1979, the economy saw double-digit price increases and rising unemployment. Carter felt obligated to implement stricter price controls than Nixon had implemented, which only squeezed small and medium-sized businesses even more.
The Reagan Administration