When the fabric of society is torn, as it is today, wise men do not shout "Chaos" just as they do not shout "Fire" in a crowded auditorium. At such times they remain cool. They recognize that those in charge have become confused by poor judgment and serious mistakes. We here today have increased our own capital while others were losing theirs and earned the respect of our fellows because we correctly anticipated these present disorders. If we are to continue as useful members of society we cannot say "I told you so" nor shout "The Russians are coming." America is big enough to correct itself. Let us help.
Why does our government declare it illegal for us to own gold? Is it not because Congress steadily abdicated its functions in favor of the President until in recent years he became sovereign? He alone engages us in wars. Control of money was given by Congress to the Federal Reserve, a bureaucracy held in fief by the sovereign. Constitutionally both war making powers and the regulation of money are Congressional functions. When power is so centralized, it is fought over by power hungry men. From such conflicts emerge men unfit to govern. Instead they steadily restrict our freedoms so that they can rule without restraint. The freedom to own gold is among the first to be lost.
But I am encouraged. Congress is now trying to recover its authority. A mild limit on the President's power to wage war was passed over his veto. The "emergency" Gold Act of 1934 was lifted by Congress. It still did not have the authority necessary to take the decision away from the President, but I think it will in time. These are signs that the people learn even without leadership. They learn, not from their elected leaders, but from teachers such as "The National Committee to Legalize Gold." Mr. Blanchard and his Committee should be congratulated because they have gone to the heart of one of the two major problems disrupting our country. I must now move on to that lugubrious word:
For the first century and a half the people of this country were interested, sometimes passionately interested, in how their money was created, circulated, and who benefited. Since World War II this interest has evaporated. Discussion surrounds consequences, not causes. Inflation and controls stir passions today. Yet inflation is the result of the depreciation of money. Why do not the people insist, as they did in the past, that they be told how money is depreciated so that it can be corrected? The answer, I believe, is that we have created since World War II a new class in society called economists who are really educated fools. Except for a handful, most of whom are here, they are dull, uninquiring of mind, have no desire to learn the truth, and abandoned common sense when they received their diplomas. So today the public is misled into believing that the result is the cause. For economists to be as effective in misleading the public, as they have been, they had to have a powerful arm of government backing them. This was found in our Federal Reserve System with its own interests shared by economists. When ownership of gold was first forbidden the Fed was spending about $25 million annually of our taxes. Today it spends almost $500 million. Its staff has proliferated tremendously; its senior officials have repeatedly insisted that they control our money and would lose control if we are permitted to own gold. Economists who, without question, accept their word find a home in the Fed. When, at last, in the Kennedy Administration the Fed captured the Treasury with such men as Roosa, the Fed and the profession of economics became as powerful as the Pentagon. Why would they admit that they had been continuously wrong, and thus miss out on a good thing? Objective evidence of inflation, high interest rates, and two devaluations did not convert them because long ago bureaucratic necessities replaced the good of the country. When stating a minority opinion, as I am accustomed to do, I must, unlike those who swim along with the majority opinion, prove to be true to what I have said. So let us examine that institution a little closer.
THE MIRACULOUS FEDERAL RESERVE
Beginning in 1958, 1959, and 1960 our sales of gold became such a flood that our gold reserves sank to $17,954 million from a previous high of $25 billion. When, in a brief period of time, $7 billion of gold is bought by foreigners at $35 per ounce any rational person would conclude that we were selling it too cheap. Not so the Kennedy Administration. Influenced by Mr. Roosa, who was moved from the New York Fed to the position now occupied by Mr. Volcker, it was decided to keep the price at $35 by force. As was to be customary for all matters in succeeding years, no attention was paid to the fact that our gold was a finite sum. How did it end? After $4.5 billion more had been sold, by the fall of 1967 the Pentagon became alarmed. It insisted that a floor of $10 billion be set to protect our wartime necessities. In the next six months $3.4 billion was sold. At precisely the $10 billion balance, on March 18, 1968, sales were stopped. After 60 percent of our gold had been sold at $35 per ounce, the average American would assume those responsible would be discredited and the economics profession institute an inquiry. Instead both drew a curtain between the public and the truth. That curtain read "A great advance in money management. We are succeeding in demonetizing gold."
In 1961 Mr. Roosa also pushed for "swaps" to be run by the Fed. Congress was ignored. Mr. Kennedy, Attorney General, gave Mr. Kennedy, President, the legal opinion that he had the right to authorize them. When Mr. Roosa publicly announced them and stated that this innovation was a great advance, because the Fed had much more power in this field, I wrote a reply and sent a copy to Alfred Hayes, president of the New York Fed. My reply made quite clear that the Fed had no power at all in this field because the Treasury owned the gold necessary for ultimate settlement, and the Fed could act only as agent for the Treasury. Mr. Hayes was very angry. In fact an old friend of mine, George Ellis, then president of the Boston Fed now head of Keystone Funds, told me that the whole top echelon of the Fed was furious. That didn't mean they were learning. Even after a number of trips to the Treasury to obtain $100 or $200 million of gold for settlement, they still did not learn.
Beginning in May 1971, the Fed started selling huge quantities of foreign currencies in the forward market without making provisions for "swap" cover. When the time came in August to deliver the currencies it had sold, it had no plans. The Treasury was too near the $10 billion floor set by the Pentagon to help out, yet over half of the $3 billion short position was due New York banks, who in turn owed it to their customers. Surely only fools or economists could have gotten themselves into that position. What did the Fed do? Like "go-go boys" caught in a similar bind, it resorted to fraud with a coverup. Over $1.0 billion foreign currencies were borrowed from the Swiss Bank, the B.I.S., and the Belgian Central Bank on Wednesday and Thursday, and on Friday $750 million from the Bank of England. On Saturday the fraudulent default came. With it went the Bretton Woods agreement that for a quarter of a century had been the cornerstone of economic cooperation with our allies. The cover story was wage and price controls. Not only the press, as you might expect, was deceived by the cover story, but also the economics profession which, at least, should have sought to find out what happened. Congress slept as soundly as ever. The cover story had worked. Only our allies, who had been betrayed, were angry, but they don't vote in our elections. Gold became increasingly dear as more people learned that a government issuing only paper money cannot be trusted.
The increasing centralization of government produces a corresponding dependence among those whose freedom means little to them. Among these are economists. When the Federal Reserve began stating in louder and louder terms that it could create money at will, economists believed it. They ignored basic accounting rules or even the common sense that clearly denies that any person or institution can create something out of nothing.
The Fed claims that it can buy or sell any amount of Treasury securities it wishes. It claims it does this by crediting member banks' reserves (a deposit by banks in the Fed). Once a week the Fed issues a balance sheet that is reported in the press and is available free for the asking. Do economists look at it? No! If they did, they might see that, from the one I have in hand, Treasury securities totaled $76,565 million but member bank reserves were only $28,378 million. Where did the $48 million discrepancy arise? Or if they wish to look in the FEDERAL RESERVE BULLETIN they would discover that on December 31, 1941 the Federal Reserve owned only $2,219 million Treasuries but member bank reserves were $12,812 million. A little arithmetic would reveal that Treasuries rose $74,346 million during a period when member bank reserves rose only $13,568 million. Surely some economist should have asked where over $60 billion Treasuries came from that are not accounted for in the Fed's explanation. Surely there must be some economists who know that assets and liabilities must equal each other. But none, but the few here, in or out of the government raised such questions.
They did not even ask why Morgan Guaranty would sell $25 million Treasuries to the Fed for a noninterest bearing deposit in the Fed. Yet obviously when the bank did, it had in mind reducing that deposit by a like amount and buying other Treasuries or loaning to U.S. Steel. The record shows that all government bond dealers accredited to the Fed did just that. How then did the Fed balance its books? What effect did these transactions have on the money supply if the dealers were merely substituting one government security for another or loaning to a company rather than Uncle Sam? How could deposits rise and thus reserve requirements? You will not find an answer to any of these questions in universities or the books published by the Fed. So I must supply answers if we are to see how our money system really works.
Ninety percent of the Fed's income comes from interest on its Treasury securities—interest paid by the taxpayer. Out of this total of about $3.5 billion the Board of Governors allotted itself $43 million for the year ending December 31, 1970. Of this $22 million went to the Bureau of Printing and Engraving for new Federal Reserve notes and to the Federal Reserve agents in each bank to keep a record of them and destroy those no longer fit for circulation. Consequently new notes arrived in the Federal Reserve agents' hands without cost. The Federal Reserve banks themselves acquire these notes without cost by delivering worn out notes or providing the agent with the serial numbers of Treasuries they had acquired. Formerly, they could also acquire these notes by specifying the gold certificate numbers they owned, and before that, gold. The Federal Reserve sells this currency on demand to member banks at face value thus profiting by 100 percent. Out of this 100 percent profit it buys equivalent Treasury securities to satisfy the Federal Reserve agents. On the weekly balance sheet I showed you earlier, the Federal Reserve Agents' Accounts show $65,192 million Federal Reserve notes outstanding of which collateral was $64,530 million Treasury securities and a small balance of gold certificates. The Treasuries pledged with the Federal Reserve agents were 86 percent of all Treasuries owned by the Fed that week.
Shall I draw the clear conclusion that the Fed has made a profit since its beginning of $65,192 million from the demand by the public for more and more paper currency? Shall I also draw the clear conclusion that the discrepancy between the Treasuries owned, and member bank reserves, has been accounted for? Finally the retention by the Fed of all this profit and its investment in Treasury securities creates an inflation of like amount. What sense does Dr. Burns make in demanding in 1973 price and wage controls when his own organization depreciated money in 1973 by over $5 billion?
Before 1934 the Federal Reserve owned all our monetary gold. When it bought gold, it paid for it; when gold was sold, it received the proceeds. The amount of Treasury securities held rose or fell by the same amount—thus creating instability in the money markets. President Roosevelt transferred, ownership of this gold to the Treasury to avoid arguments with the Board of Governors over purchases of gold to get the price up. However he did not want the Treasury to pay for these purchases as he was already being severely criticized for a large budget deficit. Consequently gold certificates were given to the Fed for the amount of gold received, and more with each purchase. As the Fed accumulated more certificates, it credited the Treasury with a deposit for a like amount, and the Treasury paid for the gold. Thus the reported Treasury deficit would be less, and the Treasuries held by the Fed would decline as it was forced to sell to honor the Treasury's withdrawals. That is why the Fed had only a little over $2 billion Treasuries in 1941 and this process became a major factor in prolonging the depression seven years. Eighteen billion dollars of gold purchases were handled that way. For the 11 years ending March 18, 1968, the process was reversed. Fifteen billion dollars of gold was sold. The proceeds were given to the Federal reserve who invested them in Treasuries and with the multiplying factor caused inflation, or rather depreciation of our money by $100 billion or more.
I believe I have now proven my minority opinion that the inflation we have suffered has been the result of the depreciation of money by the government, and that this has been allowed to happen because the economic profession consists of educated fools.
Since it is hopeless to believe that the executive branch, or the Federal Reserve, or economists can work out a cure for this situation until we run into a major depression (if then), I will attempt to outline it now.
Paper currency is an easy matter. Only the Treasury should issue it, sell it to the Fed at face value, and use the profits to retire debt. This can be short cut further by the Fed delivering the Treasuries it purchases out of its currency profit to the Federal Reserve agents to be destroyed along with the used Federal Reserve notes. Only a small amount of presently held Treasuries need be kept in a suspense account for seasonal fluctuations. No further inflation would arise from this source, or deflation as happened in 1949 and the mid-1930's, when the public uses less currency.
The gold problem is somewhat more complex. The objective should be a limitless circulation of gold coins of two denominations. One should contain one ounce and the other one-half ounce of pure gold. When inflation occurs because government expenses are too heavy or banks are financing the deficit, the public will acquire more gold coins. This in turn reduces bank deposits, which reduces bank credit, which in time brings the government and bankers back to their senses. The process also works in reverse. Consequently it is the most potent stabilizing force yet devised. It justifies "The National Committee to Legalize Gold" as the single most useful committee in America.
But a limitless circulation of gold coins against a finite amount of gold means that price must take up the difference between supply and demand. The first decision must be, therefore, that the coins cannot have legal tender value. Most of our money is not legal tender because 95 percent of money payments made today are by checks that are not legal tender. The usefulness of legal tender is chiefly to provide a legal basis for action against counterfeiters. No legal tender—then no face value. However, since the gold coins will be used as money, there should be no tax on profits nor credit on losses. A further refinement is that all institutions—the Treasury, the Fed, banks, etc., account for their transactions on a Last-In-First-Out not a First-In-First-Out basis. Individuals need not account for their transactions.
With this clearing away of several problems we can proceed on how gold coins can be put into circulation without disturbance to the monetary system. The disorders in the world that have already pushed the price of gold higher will increase the price if the government announces not only that Americans can own gold but the government will mint gold coins. At $200 per ounce the Treasury's gold stock has a market value of about $60 billion. All of this should be converted into coins with, as we mentioned earlier, no stated value but a guaranteed weight.
Of this, $10 billion must be set aside for the Defense Department. Although this is less by weight than previously required, the government can easily get, in an emergency, most of the balance from its own citizens, as we shall show, just as the British government did in World War II. The remaining steps are as follows:
1. The Treasury sells gold coins to the Fed at the daily market price.
2. Commercial banks buy their requirements on the same basis.
3. The public buys from commercial banks at this price.
4. The Treasury, Federal Reserve, and Commercial banks will require some inventory. That is why they must account for it on a LiFo basis.
It is desirable, however, that banks as well as private individuals become aware of the significance of gold as money. Consequently the noninterest bearing and frozen reserves which they must today keep on deposit in the Federal Reserve should be converted into gold coins. The Treasury can sell $28 billion of their $60 billion to the Fed at current prices in exchange for Treasury securities held by the Fed and cancel those securities. Second, the Fed should sell, at the same price, those gold coins to member banks in exchange for canceling their deposits with the Fed. Congress would then require that all banks must keep half of their capital and surplus in gold coins. This approximates the $28 billion member banks already hold. From that point on the Treasury will maintain an inventory, in excess of the Defense Department's requirements, by buying or selling in the open market or with special deals with other governments. Never again will it commit its gold reserves to guarantee another international parity for the dollar. The dollar must float.
If these changes are made, it will end inflation or deflation by the Fed. If banks are refused the right to borrow money except from other banks, and also are careful about lending money to the Treasury, then bank credit expansion will not depreciate money. How to keep government spending to reasonable levels is a different and even more complex subject that is beyond this analysis.
No doubt the times will get worse before they get better, but this is the period in which your weight can be felt, as the previous generation's was not during the continuing Roosevelt depression. May I also point out that the Roosevelt solution of a World War is no longer available to us today?
If you wish to avoid a depression, then paper currency, gold, bank credit, and government spending must all be subjected to rational analysis and correction. Since economists, the Federal Reserve, and the Treasury are all opposed to this, then our unfortunate fellow citizens can only hope that we get a competent Secretary of the Treasury before too long.
The cheerful element in this sad story, as I mentioned earlier, is that those who take the trouble to understand money can continue to increase their capital as they watch the government continue to create disorder.
Alden Rice Wells is the editor and publisher of the ALDEN R. WELLS MONETARY REPORT, an investment advisory newsletter, and the ALDEN R. WELLS QUARTERLY, a general review of society with emphasis on money and taxes. Mr. Wells presented the text of this article to the 1974 Monetary Symposium, sponsored by the National Committee to Legalize Gold, in New Orleans in January.
This article originally appeared in print under the headline "The Federal Reserve vs. Sound Money".