All Commentary
Sunday, August 1, 1982

The Illusion of a Riskless Society

Dr. Elgin Groseclose, a financial consultant in Washington, D.C., is the author of Money and Man (1934, 4th edition 1976) and America’s Money Machine (1966, 1980). He serves also as executive director of the Institute for Monetary Research.

Throughout history the fear of insecurity, from floods or famine, from enemies without or within, has driven mankind to erect barriers against the onset of disaster. Throughout history also such barriers-from the barns that led the man of the parable to tell his soul to take its ease, to the walls that cities have built that eventually fell to some invader-have proved illusory. In this country, protected as it is by the barriers of two great oceans, the search for security is no less fear-driven, but its direction, in an increasingly monetized society, is in a search for bastions. And since this is an increasingly socialized society, a chief aim of political policy has been to provide, through governmental agencies and power, what is currently referred to as a “safety net” for every citizen.

Yet as we may observe, the search for such security has proven illusory—mainly because of decay of its fabric, that is, the monetary standard of which the net is woven. We may review a number of these efforts by government.

First Effort—Riskless Banking

Throughout the latter decades of the nineteenth century, “check book money” came into increasing use as a medium of payments. But check book money depended upon the solvency of the bank in which the real money was deposited. Bank failures became a periodic feature of eco nomic history.

In 1913, following the “rich man’s panic” of 1907, the result of over-speculation and bank failures, public outcry for a “flexible currency” brought forth the Federal Reserve System designed, in the words of the Secretary of the Treasury, to “make panics mathematically impossible.” Banking was to be made riskless for both banks and depositors by allowing overshot banks with cash shortages to trade collateral for legal tender currency at the Reserve banks. With this assurance of liquidity, banks were now allowed to reduce their capital reserves against deposits from a standard 25 per cent to a sliding scale down to 12 per cent and as low as 5 per cent on time deposits. Under subsequent legislation and regulations, also, banks were able to shift more and more of their assets from short term self-liquidating commercial paper to long term mortgages and bonds, thereby ira-pairing their liquidity and ability to meet sudden withdrawals.

This effort to create riskless banking collapsed in the securities market panic of 1929 which led to the bank “holiday” of 1933 when every bank in the country was forced to close its doors.

Second Effort—Riskless Deposits

The country now concluded that, however feeble the banks might be, whatever extravagant ]ending they might indulge in, their customers, at least the smaller ones, should be protected and their deposits made riskless. This led to the enactment in 1933 of deposit insurance legislation by which eventually two mammoth government corporations, the Federal Deposit Insurance Corporation and the Federal Savings & Loan Insurance Corporation, were set up “to restore confidence in the banking system and protect depositors.”

By 1979 the futility of this effort became evident to the bank regulators. Thus, in 1979, William M. Isaac, president of the FDIC Corporation, pointed out that the risk assets of the banking system—total assets less cash and equivalents—had risen from 22 per cent in 1945 to 80 per cent by 1978. He commented ominously, “One would think that with banks assuming greater risks, and the economy more volatile, capital ratios would be increasing. Just the opposite.” He cited that equity to risk, that was around 30 per cent in 1900, had dropped steadily to around 8 per cent in 1978.

Today the cause for concern is greater. The New York Times for January 25, 1982, noted that of the 15 largest bank holding companies, the equity to assets ratio ranged from 4.55 per cent to as low as 3.25 per cent; and we may add that if bankers’ portfolios were valued at market, the result in many cases would be a negative ratio. Take, for instance, a Aaa bond like AT&T 7s of 2001, issued in 1971 at 99.25, that has sold recently for as low as 50.

Presently the savings and loan associations are approaching crisis under the necessity of borrowing at rates up to 15 per cent against mortgage assets acquired when rates were as low as 8 per cent; and each day brings reports of new mergers ‘and take-overs to save failing associations from outright default. The most recent merger was reported on March 24, 1982, “to avert what would be the biggest bank failure in the nation’s history.”

With customers’ deposits now guaranteed up to $100,000, the $8 billion insurance fund of the two corporations has become totally inadequate as guarantee. This has led to legislation to back up deposits by the “full faith and credit of the U.S.” regardless of the adequacy of the insurance fund. A bill to this effect was passed by the House with only 10 minutes of debate; its fate in the Senate has not (at this writing) been resolved. Other proposals are for the government to subsidize $210 billion in old low-interest mortgages by paying half the difference between the yield and the market rate on current deposits—a procedure that The New York Times estimates could cost the taxpayers from $4 to $5 billion a year for many years.

Third Effort—Riskless Aging

In 1933 the government undertook to guarantee income for the aged through a Social Security system by which a percentage levy was laid on earned income, the proceeds of which were invested in government bonds, from which payments were made as the contributor reached retirement age. Starting out at a modest percentage of earned income, the levy has steadily increased to a 1981 tax of 9.3 per cent on income up to $29,700. Since the tax receipts were invested in government bonds, for nearly 50 years the system has been a means of covering federal budget deficits; today, however, due to steady increase in benefits, the system is facing bankruptcy unless relieved by further taxes either from the income contribution or general revenues.

When Joseph foresaw a famine in Egypt he stored harvest surpluses of the good years in granaries against the years of dearth. Such a method is impossible today in a system of debt money. Who is to provide cash against the bonds but the very ones who are in need?

Fourth Effort—Riskless Prices

Since 1922 government policy has been to stabilize prices in order to protect producers of goods and services from loss from price fluctuations. This is theoretically achieved by the Federal Reserve System in buying and selling government bonds to provide an even supply of money. But the essence of trade is differences in prices. If all prices were stable, enterprise would wither, as the effect of rent control on housing supply has demonstrated. If modern technology means anything it is to make goods cheaper.

The secular effect of the policy of maintaining prices has been a steady increase in prices, with the increase steadily accelerating until it reached double-digit rates in 1980 and produced a voters’ revolt.

Fifth Effort—Riskless Money

All the efforts to remove risk from banking, from livelihood, from enterprise have been, as we have noted, through the agency of money. Money is the foundation stone in the wall of security. But money, no longer a substance, like gold or silver, but an I.O.U. of the Federal Reserve System, a note without maturity, melts away like shifting sand under the cyclical rainfall of business.

The last element of substance in money disappeared in 1971, when the “gold window” was finally closed on international holders of dollars. Since then, holding money has become the greatest risk of all. This has become evident in the rising interest rate demanded by lenders to offset the erosion of the dollars due them. This rise in interest rates has been going on for the past 40 years, generally unperceived until the last decade.

Sixth Effort—Speculation

The disappearance of financial stability has led inevitably to a surge of speculation and gambling. As the Minority Report of the Gold Commission points out, scheming, speculation, and sophisticated tax avoidance have replaced productive effort, savings, and planning for the future.

Trading in currencies, the Report adds, has become more rewarding to banks than conventional business of brokering loans from savings. The futures and options market has turned into a giant gambling game. Futures are sold in currencies, and more recently futures and options on stock-indexes. In 1980 more futures on Treasury bonds were sold on the Chicago Board of Trade than on cat-tie. Billions of dollars are obtained from banks by corporations for the purpose of “take-overs” of other corporations with no indicated purpose of developing new industries or sources of basic wealth. Gambling has become a state enterprise. Illegal for individuals, in 1980, over $2 billion was gained from official lotteries for the benefit of state governments.

The High Road to Stability

Despite the evidence of an increasingly unstable society due to the monetary standard in which business is done—despite also a so-called “tight money policy” by the Federal Reserve—the printing press continues to roll and the amount of debt on demand continues to rise. Between February 28, 1981, and February 28, 1982, corresponding closely with the first year of the Reagan Administration, the legal tender circulation increased from $131,862 million to $140,525 million, while the demand debt of the Federal Reserve bank and banking system (called M1) rose from $424 billion to $447 billion. Since none of this debt is dischargeable in any legal tender but irredeemable paper, it is obvious that until the powers of the Federal Reserve to create fictitious money are curtailed, no degree of stability will be achieved.