Sunday, January 16, 2011

Analysis of the Monetary Reform Act — Part II

Analysis of the Monetary Reform Act — Part II
Thomas Allen

This is the second part of a paper analyzing the “Monetary Reform Act” as it appeared on November 3, 2010. This Act and a description of it can be found at

I have italicized words of the Act and its footnotes and my paraphrases and summaries of their words. My commentary is in roman letters.

Section 10, Treasury Deposits, authorizes the use of money placed in Treasury Department Deposits “pursuant to appropriation by Congress, to pay for goods, services, or interest needed by the federal government.” Funds “in excess of federal expenditures not funded by tax revenues” are rebated to individuals via the income tax system. Future monetary growth under Section 7 funds withdrawals greater than receipts. If withdrawals exceed this amount, then tax increases cover the excess. If Congress does not increase taxes sufficiently, the Secretary of the Treasury may add a surcharge to the income tax sufficiently to cover the deficiency.

This Section does not have any more force to constrain using printing press money to fund deficit spending than the other Sections. It puts pressure on the Secretary of the Treasury to act. It authorizes, but does not require, him to place a surcharge on income taxes. Will the President in the absent of Congressional approval choose the unfavorable reaction to a tax increase? Possible, but not often.

What this Section does is to allow Congress to increase taxes without having to vote to increase taxes. It appropriates funds to satisfy its favorites. Then, the Secretary of the Treasury raises the taxes necessary to pay for the deficit. That the Secretary would choose to raise taxes on his own is not likely. Contrary to the intent of the Act, printing press money will cover most deficit spending.

Besides breeding corruption, such action harms the economy. Money is taken from the productive and given to the politically influential. Thus, the economy becomes less productive.

Section 11, Interest, describes paying interest on Treasury Department Deposits. One of Mr. Carmack’s objectives is the elimination of federal debt. Yet the Act allows banks under Section 9 to invest in Treasury Department Deposit accounts. In Section 10, the Act allows Congress to appropriate all the moneys in Treasury Department Deposits — and more. Section 11 describes the paying of interest on Treasury Department Deposits. To me this looks like and sounds like banks lending the government money.

Moreover, Mr. Carmack has reintroduced fractional reserve banking, or at least its essence, that he wants to outlaw. Section 9 allows banks to count money invested in Treasury Department Deposit accounts as reserves for the 100-percent-reserve requirement for checking accounts. Thus, money in these Treasury Department Deposit accounts is immediately available for the checking account depositors to use. Section 10 allows Congress to appropriate funds placed in Treasury Department Deposits. Thus, the Act allows two different parties, Congress and the checking account owner, to use simultaneously the same money. Simultaneous use of the same money by multiple parties is the essence of fractional reserve banking.

Mr. Carmack realizes this problem with banks. He requires 100-percent reserves for banks to prevent simultaneous multiparty use of money. Apparently, he does not realize that the government is acting like a fractional reserve bank when it spends deposits used to back checking accounts. Thus, he defeats himself in trying to outlaw fractional reserve banking.

If he does not intend for the government to engage in fractional reserve banking and wants to end routine governmental borrowing, he needs to prohibit any bank, private individuals, associations, and companies from having Treasury Department Deposit accounts.

Section 12, Lending Institutions, gives the requirements for lending institutions. These include “investment trusts, mutual funds, brokerage or lending houses.” They may sell stock and may receive, borrow, lend, or invest money at interest but only with existing funds, i.e., U.S. notes and Treasury Department Deposits. They cannot be called banks. “[A]t no time may more funds be subject to demand than are presently idle and one hundred per cent (100%) available on demand.” This provision seems to be the Act’s prohibition against borrowing short and lending long. If so, it could be worded better. “For any funds deposited with such associations payable on demand there must be a dollar of United States Notes on hand or deposited in a Treasury Deposit.” This provision seems to be functionally the same as a checking account, “payable on demand,” although this Section prohibits calling them demand account and prohibits lending institutions from providing checking accounts. “No such association may denominate any account a demand account, nor promise immediate availability of any funds which may be invested, deposited or otherwise placed by such association without notice in any instrument or account other than Treasury Deposits.” Thus, this Section seems to be at least partially contradicting itself. Moreover, this Section prohibits the transfer of funds “by check, credit card, electronic transfer or any substitute therefor.” Does the mean that all count withdrawals and loans have to be in currency? It seems so.

Section 13, Repeal of Conflicting Acts, repeals the National Banking Act of 1864 and amendments and the Federal Reserve Act of 1913 and amendments. It transfers all Federal Reserve System monetary authority along with the Federal Reserves assets, liabilities, and employees to the Department of the Treasury. It greatly restricts the action of the Federal Reserve System during the transitional year. Federal Reserve notes are phased out, but remain legal tenders as long as they are in circulation. If this Act contained only the first sentence of Section 13, the repeal of the National Banking Act and the Federal Reserve Act, it would be a great law.

Like most other fiat money reformers, Mr. Carmack is convinced that fiat money or centralized banking per se does not cause the country’s monetary problems. Who issues the currency and how it is issued cause them.

Mr. Carmack’s proposal does not have a formal governmentally owned and operated central bank like Great Britain does with the Bank of England. (The Bank of England is part of the British government; it is a government agency.) However, the Act requires the Department of the Treasury to act like a central bank in many ways. It holds the country’s banking reserves outside bank vaults. It appears to assume the Federal Reserve’s check clearing activities. It manages the country’s money. About the only activity that the Federal Reserve performs that the Department of the Treasury would not be doing is rediscounting bills.

I do not know what Mr. Carmack intends to do with the Federal Reserve’s large staff of economists. The primary job of many of them seems to be to write scholarly articles for Federal Reserve journals. Perhaps he could use them to write scholarly articles to support his system.

Based on Footnote 8, Mr. Carmack believes that abolishing the Federal Reserve and transferring its power to the Department of the Treasury will eliminate or at least greatly reduce the power and influence of private bankers over the country’s banking and monetary policies. Placing all this power in the Department of the Treasury or any other governmental department, does not solve this problem. Bankers have controlled the Department of the Treasury in nearly every administration since Washington’s administration.

Moreover, if he wants to reduce bankers’ influence, he should fire all employees of the Federal Reserve and forbid the federal government to employ any of them ever. They are all contaminated with banker influence. Yet he wants to move all these pro-banker people to the Department of the Treasury and put them in charge of his system. If he really wants to eliminate the power of the bankers, he needs to eliminate the power instead of transferring it.

Section 14, Penalties, set forth penalties for engaging in fractional reserve banking. Does this mean that the U.S. government is going to fine itself for engaging in fractional reserve banking? Or is it above the law? When Congress appropriates money from the Treasury Department Deposits held as reserves for checking accounts and the President and his bureaucrats spend it, are they going to prison for 20 years? Or are they above the law?

Section 15, Withdrawal from International Banks, requires the U.S. government and the Federal Reserve to end their membership and participation “with the Bank for International Settlements, the International Monetary Fund, the World Bank, and all other international banks” that are “inconsistent with and in direct conflict with the purposes of this Act.” It also directs the President “to take such steps as may be necessary to withdraw the United States from all participation, and membership, in the Bank for International Settlements, the International Monetary Fund, the World Bank, and all other international banks.” The withdrawals must be achieved within one year. He must “recover the original and any subsequent United States subscriptions, contributions and quotas to such organizations, not already fully and lawfully expended, whether in the form of gold, deposits, currency or otherwise” This Section directs the President “to enter into negotiations to establish new exchange facilities” that have “no authority to create money or credit in any form” and that have “no independent authority to establish laws or regulations binding upon the United States or its banks, financial institutions or citizens.”

Withdrawal from these organizations is one of the few positive features of this Act. I question the need to enter “into negotiations to establish money exchange facilities.” Other than giving the U.S. government more control over foreign trade and by extension domestic commerce, what purpose would they serve? Companies that want to engage in foreign trade should bear the expense and risks of making their own deals.

Section 16 Foreign Exchange, directs the Secretary of the Treasury to regulate foreign exchange rates to allow “the external rate of exchange freely to fluctuate, as foreign price levels fluctuate (i.e., in accordance with their respective purchasing power), while utilizing the exchange stabilization fund and foreign currency reserves to counterbalance fluctuations in the exchange rate.” He is to adopt regulations to “1. keep the stable, internal domestic price level established by this Act unaffected by foreign exchange rate fluctuations; 2. maintain imports and exports of capital, in equilibrium.” Under no circumstances are “the foreign exchange rates [to] be allowed to alter the fixed rate of monetary growth set forth in section 7.”

In other words, the Secretary of the Treasury is to intervene in the currency markets and manipulate currencies. He is required to be a currency manipulator. If any individual or consortium attempts to manipulate the currency market, they are condemned and may even be fined or imprisoned. When the Secretary of the Treasury does the same thing, he gets paid. Mr. Carmack’s proposal breeds corruption by not only empowering, but demanding, the government to manipulate currencies.

The people who own the Secretary can make a fortune in currency markets by knowing what the Secretary will do before he does it. They will surely know because they put him in that position to serve and inform them.

Currency manipulation and speculation were not a problem under the gold-coin standard that existed before World War I. It only occurred when the fiat money accompanied the gold standard or when the government allowed banks to suspend redemption.

The Act gets worse. It requires the Secretary to intervene in the capital markets to keep imports and exports of capital in equilibrium. Thus, anyone seeking to transfer money into or out of the country will need the approval of the U.S. government. Capital could be construed to mean much more than money. It could be construed to cover just about every export and import. Thus, the Secretary may have to balance imports with exports. Anyone seeking to import or export things may have to have the approval of the U.S. government. This provision fertilizes corruption.

Furthermore, this Section also makes a false assumption. That is, this Act will achieve stable internal domestic prices. As shown above, this Act is inflationary and cannot maintain stable internal domestic prices regardless of the Secretary’s currency and capital manipulations.

One of the many fatal flaws in all fiat money reforms is their slavish reliance on politicians, which the Secretary of the Treasury is. Fiat money reformers have this puerile belief that all political leaders under their system will be statesmen who place the welfare of the country above their own and that of their friends. (Ironically, most fiat monetary reformers are aware that most of the politicians under the current system are slimy, sleazy scoundrels who always place their and their friends’ selfish desires above the welfare of the country. Moreover, bankers and plutocrats own them. Fiat money reform must be something akin to second coming. It turns sinners into saints.)

Mr. Carmack seems to try to prevent this corruption by discouraging “speculative trading in small differentials in interest on exchange rates” by charging a small fee on currency exchanges (Footnote 12). It may affect small private actors. It does nothing to stop the U.S. government or foreign entities from speculating. Is Mr. Carmack so naive that he believes that the administration will not become involved in currency speculation in the name of foreign exchange stabilization if its friends and owners demand such?

Section 18, Severability, is the severability clause typically found in new legislation. It declares if any provision is found unconstitutional, the remainder remains in effect.

Except for repealing laws and with drawing from international organizations, nearly everything in this Act is unconstitutional. However, if Congress ever enacted it, I doubt that any federal court would declare anything in it unconstitutional. Anything that increases the power and prestige of the U.S. government increases the power and prestige of federal courts. If the U.S. government has more power and prestige, so does its judges. Like most people, most judges prefer more power and prestige to less. Therefore, they are not likely to rule against this Act. Besides, seldom does a judge let the Constitution stand in the way of his personal biases and political expediency.

Unlike some fiat money reformers, Mr. Carmack at least recognizes the dangers in allowing the government to own the banks. In Footnote 13, he writes “the power to loan does not properly rest with the government, is most effectively handled at the local free market level, and is easily abused for political purposes as was the case with pre-war Germany’s Reichbank which granted loans to whomever the government chose for political reasons, as do government banks in communist command economies.” He also believes that the setting of interest rates is best left to the markets.

Also, in Footnote 13 is a paraphrase of Ms. Coogan, “[F]or the government to create money as loans is even more vicious than for private banks to create money as loans, carrying with it the power to aid (by granting loans) or destroy (by denying loans) whomever it chooses.” Both Ms. Coogan and Mr. Carmack are so focused on creating money through loans that fail to realize that what they are proposing is tantamount to the same thing. They fail to realize that when the government issues U.S. notes, it is issuing debt and, by that, is creating money by loans. It is forcing everyone to lend to it. It is indiscriminately forcing a noninterest bearing loan on everyone. (In Footnote 7, Mr. Carmack implies that U.S. notes are noninterest bearing loans. He writes “no interest would be paid on currency in circulation.”) Moreover, it never intends to pay this debt unless it pays it with more debt.

In his discussion on Footnote 13, Mr. Carmack recognizes that politics guide government instead of economics. He writes:
Decentralized, private lending agencies generally tend to loan to any creditworthy applicant, their primary motive being profit (or profit-derived power) which is maximized by making more loans; whereas governments replace this profit priority with political ends such as rewarding their supporters, the political value of which is maximized by restricting loans. So government lending tends to arbitrary discrimination for political motives, an abuse generally avoided in a truly free market lending situation.
Yet he wants to entrust the government with the management of the country’s money, which is perhaps the most important aspect of the modern economy. For money issuance, he expects economics to guide the government instead of politics. The government needs only to follow the arbitrary criteria set out in the proposed Act. However, the government can change this Act or any part of it at anytime. As shown above, it can work with and around the provisions in this Act to achieve its political ends.

Moreover, as the Act guarantees inflation, the people who receive the new money first benefit from the losses of the people who receive the new money later. People who receive the new money first have more political influence than people who receive the new money later.

Fiat money is a political creation. It is not, has never been, and cannot be an economic, market, creation. Therefore, it will always function politically. The economy is forced to adjust around it.

Another flaw in Mr. Carmack’s proposal is the inability of his scheme to remove excess money. Whereas some fiat money reformers allow removal of excess money through budget surpluses, Mr. Carmack’s scheme precludes this approach. His Act demands the government to increase the quantity of money by 3 percent per year. If the government does not spend it, it goes to income tax payers.

A monetary system exists that accomplishes Mr. Carmack’s goal of divorcing the creation of money from lending. Furthermore, it divorces the creation of money from politics and government. (No fiat money reformer really wants to divorce the creation of money from government. They need the government to create their money and force it on the people. Thus, they do not really want to divorce money creation from politics in spite of any protestation to the contrary.) It places the creation of money directly in the hands of the people. Banks are desirable, but are unnecessary. As this system uses gold or silver or preferably both, ipso facto, fiat monetary reformers must reject it. Above all else, gold must not enter the monetary system.

Like all fiat money reformers, Mr. Carmack emphatically trusts politicians and bureaucrats to manage the country’s money. He does not trust the people manage the country’s money directly. Most likely, he cannot conceive of them doing so or how they could do it. (Fiat money reformers seem to trust the people always to elect saintly omniscient statesmen to office, who in turn will hire only saintly omniscient bureaucrats to manage the country’s monetary system. Yet they cannot trust the people to manage the country’s monetary system directly, which they can do without the necessity of omniscience or saintliness.)

Except the greenback era, the people managed the country’s money directly and without the government, except as a minter of coins. Between 1789 and 1933, when the government did intervene in the management of money, it did so to the detriment of the people’s management. Its primary intervention during this era was to protect bankers. When enough bankers failed to keep their promise to redeem their notes in specie on demand, the government intervened to relieve them of this obligation. It should have sent them to jail for fraudulently violating their promises.

Like all fiat money adherents, Mr. Carmack seems convinced that not enough gold exists to function as money today. As I show in “There Is Enough Gold” and with additional amplification in “Response to Dale’s Analysis of ‘There Is Enough Gold’” that enough gold exists to accommodate world trade several times over.

Mr. Carmack suffers from an ignorance common to all fiat money adherents. Like them he misunderstands the nature of money. Murray Rothbard describes this ignorance as follows (I have substituted “fiat money adherents” for Prof. Fisher in Prof. Rothbard’s description along with the connecting verbs):
[Fiat money adherents show] a total misunderstanding of the nature of money, and of the names of various currency units. In reality, as most nineteenth century economists knew full well, these names (dollar, pound, franc, etc.) were not somehow realities in themselves, but were simply names for units of weight of gold or silver. It was these commodities, arising in the free market, that were the genuine moneys; the names, and the paper money and bank money, were simply claims for payment in gold or silver. But [fait money adherents refuse] to recognize the true nature of money, or the proper function of the gold standard, or the name of a currency as a unit of weight in gold. Instead, [they hold] these names of paper money substitutes issued by the various governments to be absolute, to be money. The function of this “money” was to “measure” values.[1]
Prof. Rothbard continues:
Under a fiat system, the currency name — dollar, frank, mark, etc. — becomes the ultimate monetary standard, and absolute control over the supply and use of these units is necessarily vested in the central government. In short, fiat currency is inherently the money of absolute statism. Money is the central commodity, the nerve center, as it were, of the modern market economy, and any system that vests the absolute control of that commodity in the hands of the State is hopelessly incompatible with a free-market economy or, ultimately, with individual liberty itself.
Mr. Carmack appears to be blending Milton Friedman’s and Gertrude Coogan’s proposed monetary reforms. Unlike many fiat money reformers, he attempts to restrict the government’s power to issue money. As shown above the government will quickly overcome these restrictions. He recognizes the dangers in allowing the government to have absolute power. Still, he wants to give it absolute power over the country’s money, which it can use to control nearly everything else in the country. Like all fiat money reformers, he trusts politicians and bureaucrats with the management of the country’s money, but he fears the people managing it directly. He trusts paper and promises and distrusts that which is no one’s obligation or promise, i.e., gold and silver. Along with all other fiat money reformer, he can tolerate almost anything monetarily except having gold as money.

1. Murray N. Rothbard, “Milton Friedman Unraveled,” 2003 (from the Journal of Libertarian Studies, Volume 16, no. 4 (Fall 2002), pp. 37–54), rothbard43.html, October 25, 2010.

2. Ibid.

Copyright © 2010 by Thomas Coley Allen.

Part 1 

More articles on money.

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