The Great Money Hoodwink
In which the forty-third President comes to understand the raison d'être of the Federal Reserve.
Jimmy Gunn, 43rd President of the United States, entered the Oval Office, sat down behind the giant desk, and with a loud guttural hawk prepared himself for another day of seat-of-the-pants navigation of the world's most powerful, still quite productive, totally bankrupt, welfare state.
President Gunn pushed the button on his intercom and said, "Send in Blandish."
Dr. Clarence D. Blandish, chairman of the President's Council of Economic Advisors and holder of a variety of degrees in both micro- and macro-economics, entered the Oval Office.
"Good morning, Blandish," said the President. "1 hope you are fine and things are going well. Don't bother to answer that. I'm kind of rushed this morning, and I would like to get right down to it."
"Thank you, Mr. President," interrupted Blandish.
The Commander-in-Chief beckoned him to a chair, offered him a cigar, which he refused, lit one himself, and then proceeded.
"As you know Blandish, a president gets a lot of crackpot mail. I've been getting letters from this nut who thinks he knows something about economics. He says he's been watching pretty closely, and he believes there's some financial sleight of hand going on around here."
"Really, Mr. President, I'm sure that…"
The President raised his hand for silence. Then he walked briskly to the office door to make sure that it was tightly closed. When he returned, he reached into a drawer, pulled out a file of neatly typed letters, and tossed it carelessly on his desk.
Then the 43rd President of the United States looked his chief economic advisor right in the eye and said, "Blandish, this nut thinks the Fed has been passing bad checks."
Blandish stared in disbelief.
"Why that's the most absurd thing I ever heard!"
"I know, I know," said the President.
"Besides," said Blandish half-jokingly, "the Federal Reserve can't pass bad checks."
"Why can't it?"
"Because if the Fed writes a check, it's perfectly legal just because the Fed wrote it."
The President looked puzzled.
"Blandish, are you telling me that nobody, including the President of the United States, can cash a check when he doesn't have money in the bank—but the damn Federal Reserve can?"
"In a manner of speaking, yes," said Blandish. Then, when he saw the expression on the President's face, he decided he'd better explain.
"You see, Mr. President, to help stabilize the economy, the Federal Reserve has the legal power to vary the amount of money in circulation. It does this in one of three ways: by lowering bank reserve requirements; by varying the interest rate it charges member banks on short-term loans; or by its favorite way—buying government securities in the open market."
The President nodded that he understood.
"For example," continued Blandish, "if the Fed wanted to increase the money supply, it might go into the marketplace and buy a few billion dollars' worth of government securities. In effect, the Fed would be trading cash for securities, which would put more money into circulation."
"So?" said the President, beginning to fidget.
"Well," said Blandish a little more hesitantly, "now we come to the part your pen pal is probably thinking about. You see, the Federal Reserve may pay for the bond purchases by check. And it may not have all that cash right there in the till. In that case it just writes them anyway, even though the checks don't represent actual cash."
The President looked nervous.
"Blandish, are you telling me that Boon Dock Charlie, here, is right?"
"No sir," said Blandish, "it's all perfectly legal."
"But if the checks don't have any money behind them, they must be rubber checks."
"Perhaps it would be less confusing if we stopped calling them checks and called them authorizations or something like that," Blandish proposed. "In any event, the banks treat them just like real…I mean, just like other checks. They are added to deposits and become part of the base from which the banks can lend more money."
The President shook his head. "There is something screwy here," he said. Then, suddenly, the expression on his face began to change.
"Let me make sure I understand this," said the President. "The banks deposit these Federal Reserve 'things' right along with the regular money—the cash and checks that private citizens have deposited, right?"
"And once the numbers on the Fed things have been added up with the numbers on the—you know, the real money—there is no way to tell which is which?"
Slowly, a look of revelation came over the President's face.
"This is really something. It's a wonder nobody ever thought of it before."
"Thought of what?" asked Blandish.
The President was getting excited.
"Why, I'll just declare a moratorium on the whole damn federal income tax!" he said.
"You'll do what?" exclaimed Blandish, stunned.
"Why, what the hell," said the President. "Those Federal Reserve things are much too valuable to waste on the banks. We'll just have the Fed turn them over to the US Treasury. Then the Treasury can mix them all up with the real money it borrows from the private sector, and there will be no way anyone can tell the difference."
Blandish stared, speechless.
"Then, we'll take the new mixed up money and use it to pay for the federal budget. No one will have to pay an income tax. People can spend their own earnings on themselves. The economy will boom. Why, if we have enough of those Fed things left over we might even pay off the national debt!"
The President reached excitedly for the telephone, but Blandish quickly put his hand over it.
"Hold it! You can't do that," admonished Blandish.
"And why can't I?" shouted the President, as if his authority had been challenged.
"Because it won't work," cried Blandish. "The damn thing won't work!"
The President glared at him for a moment. Then, struggling to keep his cool, he sat back in his chair and relit his cigar. When he spoke next, his voice sounded as if it could freeze the contents of a blast furnace.
"Blandish, all I want to know is this: If it will work, for the Fed and the banks, why won't it work for the Treasury and the federal budget?"
Blandish's head was reeling.
"Well for one thing," he said, stalling for time, "we are talking about a lot more money—$300 to $350 billion for the current budget alone…never mind the national debt."
"But if the Fed things work for a few billion, why won't they work for a lot of billions?" asked the President.
It took Blandish a moment to think of the answer.
"The problem is, even though you can't see a difference, there really is one," he said, "because the Fed is actually dealing with two separate types of money: old- fashioned money and modern money."
"There's a difference?" asked the President.
"Oh yes. You see, in the old days, all money represented was just private wealth."
"I thought that was all money was supposed to represent," said the President.
"No, no," said Blandish, disparagingly. "Modem money also represents the power and authority of the State. "
The President looked confused, but Blandish continued.
"In earlier times, the only paper currency around was in the form of certificates circulated by private banks. The issuing bank promised to pay the face value of the certificates in gold or silver. As long as people respected the honor and integrity of the issuing bank, they traded the certificates just as we trade paper money today. And it was that kind of situation which probably prompted some smart statesman to realize that there was an obvious need for government intervention here," said Blandish.
"Of course," Blandish retorted impatiently. "Supposing the private bank cheated and issued too many receipts. The private citizen should be protected from that."
"Oh," said the President.
"So eventually a new kind of paper currency was invented. It retained the concept of real wealth by being redeemable in gold or silver. But it added a new ingredient: the legal sanction, power, and authority of the State," said Blandish.
"You know as well as I do you can't trade in paper dollars for gold or silver," declared the President.
"That's the part I was coming to next," said Blandish. "You see, once the government had a way to control the volume of currency, then it could help manage the economy—by decreasing the supply of money when the economy overheated or by increasing the supply when recession seemed likely."
"Stop this economic double-talk and tell me why we can't redeem dollars for gold or silver."
"Because," explained Blandish, "it turned out in practice that there were many more times when it seemed desirable to add money to circulation than to take it out. For example, on balance, in the 1960s we were adding to the money supply at a rate of about two percent annually; in the 1970s, the rate had grown to over six percent."
"So we ran out of real money to add to the economy?" asked the President.
"Well, obviously, there was a growing volume of paper currency around," said Blandish, "so the government couldn't be expected to trade all that paper money for the nation's strategic supplies of gold and silver.
"Besides," Blandish added as an afterthought, "it really doesn't matter anyway, because the paper money is still legal tender and backed by the honor and integrity of the United States government."
The President picked nervously at the mushy end of his cigar.
"But damn it, Blandish, that still doesn't change anything. You said once the Fed things were mixed up with real money, there was no way to tell the difference."
"Well, sure," said Blandish. "But you have to remember that you are combining two separate and distinct types of money. You have private-sector money, which still includes some element of private unconsumed wealth, and you're adding the Fed…ah, 'authorizations,' the government-type currency that never represented anything except the legal sanction and power of the government. So obviously, if you combine the two, you will have more units of money, but representing the same amount of wealth as before."
"So each unit of the new combined money will have to buy less?" said the President.
"Exactly," answered Blandish. "And that is why the Fed has to be very damn careful how it mixes the two types together."
The President looked frustrated.
"So getting back to your big idea," continued Blandish, "the fact is, it takes all the skill the Fed can muster to prepare enough new monetary units to meet the nation's money-credit needs—never mind the federal budget or the national debt."
The President had run out of patience, and he had come to a decision.
"Well, I don't like it," he said, clenching his cigar vice-like between his teeth, "and I'll just bet you that the President of the United States can make the Fed cut it out!"
Blandish stared aghast. "Suppose the Fed did cut it out?" he said. "Then you would be back to the system in which money only represented private wealth, and there would be no way for the government to control the money supply."
The President looked blankly.
"Then," said Blandish, choosing his words carefully, "except for taxes and borrowing, there would be no other government access to private wealth."
When the expression on the President's face began to change, Blandish decided that now was the time to let it all hang out.
"Without government control, the volume of money would not expand or contract to meet the needs of modern society. Instead of the present system in which government and the private sector share available wealth, there would be head-to- head competition at the loan window of the bank. Interest rates would rise so high no one could afford to finance a secondhand paper plate."
The President looked ill-humored, but Blandish hurried on.
"Picture the Treasury trying to roll over $100 billion of debt annually without some way for the government to first make money more easily available. Then you would have to run balanced budgets on a pay-as-you-go basis, not a down payment now and much more later, as we have done with some Social Security benefits. Under these inflexible ground rules, many taxpayers might decide that some government services are not worth what they cost."
"To sum up," said Blandish, "if we didn't have some way for government to increase and decrease the supply of money, there would have to be higher taxes or lower budgets."
That straw broke the camel's back. The President rose, indicating that the interview was about to be terminated. He shook Blandish's hand, thanked him for his help, and eased him gently but firmly toward the door.
But, just as Blandish was about to leave, the President thought of one last question.
"Just for the hell of it, Blandish, what if the government learned to live with balanced budgets, the economy grew, the quantity of money remained absolutely constant, and there wasn't a damn thing anybody could do about it—what would happen then?"
"It would be weird," said Blandish, "just the opposite from today."
"You mean prices would fall?"
"Yes," answered Blandish. "For example, take a new car that sells for $10,000 today; five years from now, the very same new model might sell for only $8,500 or $9,000."
The President thought it over for a moment.
"So if you put $10,000 in the bank and didn't spend it until you retired, then it might purchase what it takes $20,000 to $25,000 to buy today?"
"Yes, something like that," said Blandish.
"And that would be bad," said the President.
"It certainly would!" said Blandish. "That would be deflationary. And under those conditions we would just regress to an earlier stage of civilization in which there would be no way for the government to control the money supply—or to help the private citizen manage the economy."
Blandish closed the door quietly behind him.
Alone in the Oval Office, the President was silent for a moment. Then, with a shrug, he tossed the file of neatly typed letters into the wastebasket and, with a jab at the intercom button, transferred himself back into the real world of practical, down-to-earth, no-nonsense politics.
Mr. Way is a free-lance business writer.
This article originally appeared in print under the headline "The Great Money Hoodwink".