All Commentary
Friday, October 1, 1976

Fiat and the Founding Fathers

Elgin Groseclose, head of Groseclose, Williams & Associates, financial and investment consultants of Washington, D.C., serves also as executive director of the Institute for Monetary Research, Inc. He is author of Money and Man (1934), the 4th edition of which, with revisions and additions by the author, has just been published by the University of Oklahoma Press.

In this bicentennial year, it is paradoxical that with all the reverence being addressed to the Constitution by the courts, Congress, and presidential aspirants, no one has come forward to challenge the Constitutionality of our money system.

The importance of such a reexamination is emphasized by a recent Yankelovich survey reporting that the issue of greatest concern among voters was inflation (53 per cent). Inflation is obviously a problem which has eluded the skill of our money managers, working under prevailing monetary theory, and has defied the edicts of Congress to resolve.

On August 17, 1787, the Constitutional Convention, sitting as a Committee of the Whole, discussed a draft article defining the powers of Congress under the projected new Constitution. A portion of the draft read, “Congress shall have power… to coin money, emit bills of credit, regulate the value thereof…”

Gouverneur Morris, delegate from Pennsylvania, highly regarded as a financier, an associate of Robert Morris, who had been largely responsible for the successful financing of the Revolution, rose to propose an amendment. The amendment, as James Madison recorded in his Notes on the Constitutional Convention, the principal record of the proceedings, was to strike the words “emit bills of credit.” In 1787 language, bills of credit were synonymous with paper money.

“In no country of Europe,” a delegate noted, “is paper money legal tender, but only gold and silver coin.” He had no need to recall the flagrant paper money emissions of the first Continental Congress, which by 1781 had totaled an estimated $200 million, an enormous sum for the times, and which had fallen to a discount of 99 per cent before Robert Morris stopped their emission.

There was little debate. The offending language was removed by almost unanimous vote. It was clearly the intention of the framers of the Constitution that paper should not be allowed as legal tender in the new Union. To reinforce this conviction, the Convention enacted a provision forbidding the member states of the Union to emit paper money (bills of credit) or to declare as legal tender anything but gold and silver coin.

In 1831, Albert Gallatin, who had served Jefferson and Madison as Secretary of the Treasury (18011814) declared that “it necessarily follows that nothing but gold and silver coin can be made legal tender,” and Daniel Webster in a speech in the Senate, in 1836, proclaimed, “Most unquestionably there is no legal tender, and there can be no legal tender in this country but gold and silver…”

While the idea was already being debated that the supply of money should correspond to the needs of trade and some political economists argued that sovereign states coulddeclare their paper money legal tender, the framers of the Constitution held to the view that money should consist of something substantial, and that if paper were issued as an expedient it should always be representative of, and redeemable in, coin.

From this accepted principle, built into the foundation of the American political system, modern practice has so far diverged that money today consists of neither gold nor silver coin, but only a degraded alloy together with a vast amount of paper money irredeemable in any metal. John Law, the Scottish financier who became Comptroller General of France, in a disastrous experiment tried to make paper money representative of the wealth of France. What circulates today as money is not evidence of wealth but paradoxically the very opposite, the absence of wealth, that is to say, debt, which is no more than a pious hope for later possession of wealth.

“Freeing up the Money Supply”

How did this revolution occur? During the Civil War Congress, as a war measure, authorized the issuance of circulating notes declared to be legal tender. The action was stoutly debated and, while it was eventually approved by the Supreme Court, the principle continued to govern that paper money, unless fully redeemable in lawful money, that is gold or silver coin, was allowable only as a recourse of national emergency. It was not until the Federal Reserve Act in 1913 that the view became authoritative that circulating notes could be issued against evidences of debt. Until 1934 such notes could be regarded, in a sense, as representative of metal, since they were redeemable in gold, but thereafter irredeemable by U.S. citizens, and they were never full legal tender until 1965. After 1971, they became completely inconvertible in metal. At present the circulating media of this country consist of some $9 billion in degraded coin and $77 billion of Federal Reserve notes, plus a small amount of other notes.

Source of Inflation

The consequences of this revolution will be discussed later. For a moment let us look at the intellectual atmosphere in which it was nurtured. As a consequence of a sudden collapse of credit in 1907, leading to what has been called a money panic, the Federal Reserve System came into being with the object of adjusting the supply of money to finance the seasonal trade of a then mainly agricultural economy. This limited concept of “flexible currency” was soon expanded under the necessities of World War I when the Federal Reserve notes and credit were used to finance the government.

In 1923, the Federal Reserve managers concluded that the System’s power should be used in the interest of a stable price level, under the theory that as the production of goods rises the money supply must also rise at comparable rate to provide business with the means of payment. The theory flew in the face of the fact that a prime purpose of technology is to make goods more abundant, and presumably cheaper in order to be more widely distributed. It also overlooked the fact that the technology of money was being improved, through banking and credit procedures, so that a given supply of money could serve a greater volume of transactions.

Nevertheless, the theory became a justification for a steady expansion of the money supply, some economists advocating a regular, mathematical rise in the money supply regardless of the rate of physical growth. So embedded, in fact, has the idea become that both the Democratic presidential candidate Gov. Carter and such a conservative Republican as Secretary of the Treasury William Simon, have indicated that they regard a monetary inflation of three per cent annually as normal.

The use of debt money created by the Federal Reserve was further expanded by the Employment Act of 1946, by which the Federal government assumed responsibility for providing employment opportunities for all.

Purchasing Power Theory of Money

In discharging its responsibilities under the Employment Act of 1946, the managers of the System undertook a still deeper intrusion of Federal authority into management of the economy. Heretofore money had been considered to consist only of the official circulating media. The System now undertook to redefine money not in terms of its substance but of its attributes. Money was purchasing power, and since bank deposits were a form of purchasing power, the System now began to treat money as the sum of the circulation plus demand deposits. This purchasing power was called M1 to distinguish it from the official circulation, known as M. The Federal Reserve is able to influence the amount of such purchasing power by its authority over the reserves which member banks of the System must carry.

It now became apparent that there were other forms of purchasing power besides that represented by circulating notes and coin and demand deposits, and to extend its authority over the economy the System developed the concept of M2 consisting of circulating media and demand deposits (M1) plus savings bank deposits, since a savings bank deposit can obviously be converted on notice to purchasing power by means of a withdrawal or transfer to a checking account.

The Insubstantiality of Money

What is universal about all these forms of money —M, M1, M2—is that they are forms of debt rather than substance. Bank deposits represent the bank’s liabilities to depositors, secured in turn by various liabilities of others to the banks, plus a minute amount of physical assets. The liabilities consist of loan obligations of bank customers and investments, which in turn consist principally of debt instruments, that is, corporate bonds and U.S. Treasury obligations, and deposits at the Federal Reserve Bank, which in turn are obligations of that institution. The bank may also hold a small amount of physical assets, consisting of bank premises and furnishings, and real estate acquired in liquidation of foreclosed loans, and in course of sale. The bank may also hold a small amount of cash, but this cash, consisting of Federal Reserve notes and coin is again in form of obligation, unless coin is considered a physical asset to the extent of the market value of the metal contained.

The consequences of this transferring the concept of money from substance to purchasing power is to enter an uncharted realm of theory, in which the power of government to intervene in individual affairs is open to unlimited expansion. The idea of a government of limited or delegated powers disappears. Thus, the question of the extent to which credit cards are a form of money now engages the attention of the System managers, since credit cards are a form of purchasing power.

But there are other forms more elusive. Thus, if A, a grocer, gives his doctor a note of hand for services rendered, the note represents purchasing power in that A thereby acquired services without equivalent goods or services in payment. If the doctor in turn returns the note to A in payment of merchandise, he has used purchasing power that has escaped the statistics of the Federal Reserve. In short, any good or service that has exchange value is a form of purchasing power, and to put all this purchasing power under the control of the Federal Reserve is to give that agency a control or influence over the livelihood activities of the country, the extent of which is yet to be tested.

The Consequences of the New Money

We may now examine briefly the consequences of this departure from the monetary views of the Founding Fathers. In only 15 years, 1960-1975, the Federal Reserve notes in circulation more than doubled, from $271/2 billion to $77 billion, and coin in circulation from $21/2 billion to $9 billion. In the same interval the purchasing power fostered by the System in the form of demand deposits, so-called M1, increased from $141 billion to $295 billion.

The flooding of the country with such an immense amount of new purchasing power had its inevitable effect on prices, with the index for consumer commodities doubling from 88 to 167.

The virus of inflation, feeding on the lush growth of paper money, was not limited to this country, but has become a world-wide plague, a disease carried by the U.S. dollar and the American doctrine of central banking into every corner of the planet. Utilizing a device first developed and approved by the Genoa Conference of 1922, that the debts of a rich country could be counted as the assets of a poor, impecunious governments set up central banks with power to issue notes against U.S. Treasury obligations. Since the Federal Reserve notes and deposits were until 1971 redeemable in gold, such obligations were treated as the equivalent of gold.

Regrettably, the practice proved its own undoing. At the end of World War II the U.S. Treasury held about $25 billion in gold (at $35 an ounce), but U.S. fiscal recklessness, inordinate foreign aid expenditures, and excessive credit issues domestically, led the shrewder foreign governments to convert some of their U.S. Treasury debt into gold, until by 1968 the U.S. stock had diminished to less than $11 billion (at $35 an ounce). The accelerating weakness of the dollar in the succeeding years required the Treasury to put restraints on the outflow, and in 1971 redemption ceased altogether. The consequence has been a world-wide currency debacle with exchanges unstable and great banks in bankruptcy from foreign exchange losses.

Consequences—Mathematical and Moral

Space does not permit an examination of the economic and social consequences of continued inflation of prices from the issue of fiat purchasing power, and they are too evident in the mounting unrest and dissatisfaction with the political system to require description. It is necessary only to add that the unwillingness of governments to deal decisively with inflation is a leading cause of the disintegration of U.S.-European political influence in world affairs.

The reason for this political impotence lies at a deeper level than the economy. It goes profoundly to the realm of morals. Money is rightly called the life blood of commerce. When the blood is corrupt the whole body is diseased. There is an essential corruption and moral debility in a monetary system that permits a government to spend and distribute largess obtained without taxation, by a process so simple as a bookkeeping entry or the operation of a printing press, thereby to create purchasing power that enters the market in competition with purchasing power gained through the efforts of human labor and ingenuity.

Alexander del Mar quotes Antoninus Augustus: “Money had more to do with the distemper of the Roman empire than the Huns or the. Vandals,” and the system of fiat money into which this country has fallen, in violation of the Constitution, may be the distemper to which this country may soon succumb.


James Madison

That is not a just government, nor is property secure under it, where the property which a man has in his personal safety and personal liberty is violated by arbitrary seizures of one class of citizens for the service of the rest.