Jimmy Gunn, 43rd President of the world's most powerful, still quite productive, totally bankrupt welfare state, sat staring out the office window, his fingers drumming impatiently on the large mahogany desk. When the intercom finally buzzed, the President glanced at his watch, saw that it was precisely 4:33, and grunted in exasperation. "That's typical Blandish. He's late enough to bug me, but not so late I can raise hell about it!"
"Yes?" he barked into the intercom.
"Dr. Blandish is here," said a voice that was half Mae West, half army drill sergeant.
"Okay, Gladys, send him in," said the President.
Dr. Clarence D. Blandish, chairman of the President's Council of Economic Advisers and holder of a variety of degrees in both micro- and macroeconomics, entered the Oval Office.
"Good afternoon, Blandish," said the President, leading him to an uncomfortable chair next to his desk. (The President hated to have his guests get too comfortable.)
"Good afternoon," said Blandish. "You seem to be looking well. A slight flush about the wattle perhaps. Probably just a mild attack of loyal-opposition hypertension."
The President suppressed a mild urge to karate-chop Blandish in his wattle. But instead he said: "Yes, well, thank you, Blandish. Actually, if I'd wanted a rundown on my medical symptoms I would have called in my physician, not my loyal little witch doctor of modern economics."
The President offered Blandish a cigar, which he refused, and lit one himself. Then the 43rd President of the United States settled down to one of his favorite fringe benefits—a little Oval Office conversation where all those present knew their place.
"I've called you in today, Blandish, because I've decided to do something about the energy crisis. Everybody's bellowing about it. Nobody's doing anything about it. I'm getting tired of it. In any event, it occurred to me that your knowledge of the Federal Reserve might be of some help."
"Thank you, Mr. President," said Blandish, "but what does the Federal Reserve have to do with it?"
"I'm glad you asked that. You remember you explained to me how the Fed was organized to make money more flexible so there would be more of it to go around. Now we need to make energy more flexible so there will be more of it to go around. So I had an idea. What I want you to do, Blandish, is just figure out some sort of national energy reserve like we already have a Federal Reserve for money. Then we can get this whole damn energy fiasco off our backs."
Blandish took a deep breath. Then, very meekly, he said, "I'm sorry, but I don't think it will work."
"Of course it will work!" snapped the President. "The Federal Reserve works, doesn't it? An energy reserve will work too. You just have to concentrate on the details a little."
Blandish shook his head. "If you will forgive me, Mr. President, it won't work because banks and energy companies have practically nothing in common. For one thing, you're forgetting about Banker's Syndrome."
"Forgetting about it? I never even heard of it. What in the hell is Banker's Syndrome?"
"It's an occupational disease that separates banks from other businesses," replied Blandish. "The best way to explain it is to go back to banking in the 1800s. In those years it was common practice for banks to make loans by issuing banknotes that were redeemable in gold or silver. The borrower would spend his notes, but the recipient often kept them to use as money rather than redeeming them at the bank. The problem arose when bankers began to realize that many of their notes weren't being redeemed but were staying in circulation as money."
"Why was that a problem?" asked the President.
"It's your classic case of Banker's Syndrome," said Blandish. "Banker's Syndrome—B.S., as we call it familiarly in the economics game—was the banker's terrible compulsion to keep on issuing banknotes long after he had run out of gold or silver to back them up."
"You're kidding," said the President. "Cheating is a syndrome we all have to overcome."
"But, unhappily, many bankers just couldn't overcome it," insisted Blandish. "They kept right on issuing banknotes. Pretty soon, other banks who were holding their notes would get nervous. There would be a run on the banks, and the whole thing would collapse like a house of cards."
"As well it might," said the President, "because it said right on the face of the banknotes, 'redeemable in gold or silver,' right? Otherwise people wouldn't accept them as money. So when little num-num issued more banknotes than he could back with gold or silver, he was committing a fraud and belonged in the slammer like any other con artist."
"Well, in any event, B.S. is one important way banks are different from other businesses," said Blandish. "And, incidentally, this also points out why eventually we had to come up with the Federal Reserve to try to iron out some of these problems."
"What did the Federal Reserve do about it?"
Blandish wished he'd kept his mouth shut. "To begin with, the national banks—the banks that held federal charters—were required by law to join the new Federal Reserve System. The system was divided geographically into twelve districts. Each district had its own Federal Reserve Bank—a sort of mother hen, bankers' bank to all the member banks in its district."
"Some mother hen," muttered the President.
"Anyway," continued Blandish, "each private bank that joined the system had to pay an entrance fee of six percent of its capital, half of which could remain on call. These fees grew into a large reserve from which private member banks could borrow, either to lend to customers or for emergencies. Many state-chartered banks voluntarily joined the Reserve just because of these borrowing privileges."
"But what about the banknotes?" asked the President.
"The power to issue banknotes was transferred from the private banks to the Federal Reserve Banks."
"That's good!" exclaimed the President. "Ol' Mama Hen got 'em coming and going. Since the private banks couldn't issue banknotes any more, people wouldn't get uptight about Banker's Syndrome. But if some dumbbell banker got in trouble anyway, old feather-bottom was there to help bail him out."
"That's all true," said Blandish. "But at the same time you should remember that even though private banknotes were no longer being issued, private member banks could still lend credit."
"What do you mean, 'credit'?" asked the President.
"The Congress gave the Federal Reserve System authority to set reserve requirements for member banks. These requirements determine how much credit a bank can lend."
"I still don't get what you mean by credit."
"Okay," said Blandish. "Suppose a customer wants to borrow $1,000. The bank just adds a deposit credit of $1,000 to the customer's account. There is no cash transaction. The bank just accepts the customer's promissory note and says: 'Okay, you can write a check for $1,000 and the bank will honor it.'"
"You make it sound like the bank is lending something, but it really isn't money. What is the bank lending?" asked the President.
"The bank is lending credit."
"In other words, it's sort of like the 'loaves and the fishes,'" said the President sarcastically.
"No, it isn't," said Blandish. "It just means that people are willing to give the bank credit for its standing in the community. People have faith that the bank will honor all of its commitments even though its reserves are only a fraction of its deposits."
"But that's ridiculous," countered the President. "It's the same old banknote rip-off all over again. If people begin to suspect that what the bank is lending isn't really money, they'll begin to get antsy, and the next thing you know there'll be a run on the bank."
"If there is a run on the bank, I assure you, the Fed will take care of it. Now if we can please get back to this energy business."
"Don't change the subject!" commanded the President. "The first time a bank lends one dime more of this credit stuff than it actually holds in reserves, it's doing exactly the same thing little num-num did when he issued more banknotes than he had gold or silver to back them up."
"But now it's different," said Blandish. "Before, there was no Federal Reserve System to keep a bank from issuing too many banknotes. Now the Fed can keep the banks from issuing too much credit."
"But that's not the point," insisted the President. "As long as a banker is pretending to lend money he really doesn't have, he is committing a fraud and should be sent up the river like any other counterfeiter."
"Well, I don't know about…"
"Hold it!" interrupted the President. "This damn thing is even worse than I thought."
"What do you mean?" mumbled Blandish, profoundly sorry he had to ask.
"Let me see if I've got this straight now. Once before, you told me the Fed's Open Market Committee can purchase bonds with rubber checks to put more money into circulation, right?"
Blandish winced. "Please, Mr. President. We were talking about perfectly legitimate checks. The only difference was, instead of being drawn against actual cash, they were backed exclusively by the honor and integrity of the United States Government."
"As far as I'm concerned, if a check doesn't have any money behind it, it's a rubber check," said the President testily.
"Anyway," he continued, "let's suppose that the Fed, in its infinite wisdom, suddenly discovers that there are more people around who want to borrow money than the banks have this credit stuff to lend. So the Fed rushes right out and buys $100,000,000 worth of government bonds, paying the banks for them with these miserable little rubber check things that don't have any money behind them. What happens then?"
"Well," said Blandish, "to simplify it, if you assumed that the banks were required to maintain reserves of 20 percent, then the $100,000,000 would generate $500,000,000 of member bank credit."
"I knew it!" snorted the President. "Old super-bombastic feather-bottom has given birth to $100,000,000 out of thin air, which the moral heirs of the phony banknote peddlers will now parlay into $500,000,000 of this loaves-and-fishes credit stuff."
The President spat disgustedly in the general direction of a potted cactus. "Why, this funny chicken scam is even slicker than the banknote rip-off!"
"Okay, okay," said Blandish. "Just for the sake of argument, let's suppose you're right. What of it? The banks are happy. The borrowers—one of whom may be Uncle Sam—are happy, and the nation is $500,000,000 richer than it was before."
But the President wasn't listening. Suddenly he rose from his desk and started pacing back and forth. "We're not making any sense out of this with Blandish economics, so let's drag it by again in Jimmy Gunn politics," he said.
The President took a long thoughtful drag on his cigar. Then he continued: "Okay, Blandish. Let's start over again. What we are going to do now is try and put ourselves in the place of these little 19th-century banknote bandits to see if we can figure out what was going on in their heads. Then maybe we can take a wild guess at what might have taken place."
"All right," said Blandish, anticipating the worst.
"So now let's pretend that we're back in the era just before Ma Ma Leghorn came along. Some banks are making a bundle passing backless banknotes. But it's a hair-raising occupation, because sooner or later some little num-num with acute B.S. always comes along. The run on his bank triggers others, and the next thing you know there's a money panic."
Blandish shifted uncomfortably in his chair.
The President continued. "So a group of bankers who preferred counterfeiting to loan brokering call a big meeting. And the one item on the agenda is how to keep the banknote rip-off rolling without everybody getting dehorned in the process. Are you with me?"
"I'm with you," answered Blandish, wishing he wasn't.
"Okay," said the President. "So one guy gets up and suggests that they draw up an agreement that stipulates how many banknotes each bank can print. Then they will all take an oath to abide by the agreement."
"That wouldn't have worked," said Blandish, "because the government would have said it was an illegal monopoly. Besides, sooner or later, monopolies always fall apart when the greedier participants start cheating on the agreement."
"Well, scratch that," said the President. "So another guy stands up and says, since the Congress has the power 'to coin money and regulate the value thereof,' maybe a deal could be worked out by which the Congress could print the banknotes. Then, if people got edgy, they could take a run at the Congress instead of the banks."
"No, no," said Blandish. "The Congress would never have put up with that."
"Because if the Congress started printing banknotes, it could never say it didn't have enough money for a program it didn't want. Constituents would just pressure it to print more banknotes."
The President was puffing furiously on his cigar. Suddenly he smacked his fist hard into his palm. "Now I know what happened," he said. "The little banknote buddies agreed to mount a campaign to convince Congress that it should establish a separate agency to regulate money. And one of its main functions, of course, would be to print banknotes. That would take both the private banks and the Congress off the hook."
"And," said Blandish, "if the bankers decided to do that, they could have argued that it was a good way to control B.S. Because if Congress set up an agency to supervise the commercial banks, then credit would be firmly anchored in the power and authority of the US government—not just dependent upon the honor and integrity of individual bankers."
"Okay," said the President.
"As for the operation of the new money agency," continued Blandish, "it would still have to be run by bankers because, B.S. aside, banking is a very sophisticated business, and only the initiated would know how to handle it."
"I'll bet!" said the President.
"As for the name," said Blandish, hurrying right along, "'Federal Reserve System' is good because it doesn't sound like a central bank. Some people didn't like the idea of a central bank."
"Right on!" said the President. "Now all we have to do is figure out what the little banker bunglers could do to bamboozle the Congress into approving this titanic hoodwink."
"As you pointed out," said Blandish, "it would give the Congress a monetary scapegoat."
"Yes, I can see that. The bankers could make a case that if Congress ever decided to turn down a spending proposal—heaven forbid!—or there was a recession or a balance-of-payments problem—something like that—it would be nice to have someone else available to take the rap. It's a good thought, Blandish, but it's not big enough. Try and think of something bigger."
Blandish was silent for a moment. Then he said, "Is half a trillion dollars big enough?"
"Wow, what made you think of a number like that?"
"That's roughly the size of the national debt," said Blandish. "Since we're only speculating, suppose that the larger banks had refused to lend money to the government except in dire emergency. Then Uncle Sam would have been forced to live on a lower-calorie, taxes-only diet and smaller budgets. In short, it would have been pretty tough for the federal government to amass a half-trillion-dollar national debt without the cooperation of the private banks."
"My god!" said the President. "Are you suggesting the bankers would threaten to go on strike—refusing to lend to their very own government until the money agency proposal was ramrodded through Congress?"
"Goodness, no. The banks would never have dared to do a thing like that." He shifted in the uncomfortable chair.
"On the other hand," Blandish continued, "what the banks might well have done—and this is pure conjecture, of course—was to say to their more progressive friends in Congress: 'Look here. There is only one practical method by which a government can continually spend more money than it collects in taxes. That is to provide a mechanism by which the banks will always have plenty of money to lend to their government.'"
"That's it!" said the President, sliding down into his comfortable chair. "The banks got the authority to create reams of these paper credit things that could easily be circulated with a minimum of risk. Meanwhile, the government got a perpetual system for spending more money than it collected in taxes."
The President was thunderstruck by the audacity of it all. "I ask you, Blandish," he said in a fit of admiration, "was that a political deal of deals, or was that a political deal of deals? Why, it must be the prize wheelie-dilly in the history of the Republic!"
The President was silent for a moment. Then he said, "I suppose that means Old Ma Ma Hen could never let the banks go broke, because the government needs some place to keep borrowing money."
The conversation was beginning to make Blandish nervous. "Please keep in mind, Mr. President, that everything we said was just pure conjecture. And just because some of it sounded like it might make sense doesn't mean any of it actually happened that way."
The President looked Blandish straight in the eye. "Would you like to make a small bet?"
"No, I wouldn't," said Blandish uneasily, "because it's all water over the dam, now."
The President replied with a loud grunt.
"Now," said Blandish more brightly, "let's get back to this energy thing. What it boils down to is, we don't actually know the size of our energy reserves because price controls have destroyed everyone's incentive to find out. The answer is to let energy prices move to their natural market levels. That will give producers the incentive to determine what reserves can be marketed at what prices. Once actual prices are known, then each energy consumer can make his own decisions about how to allocate his energy budget."
But the President wasn't paying attention, his mind still mesmerized by the deal of deals.
"Mr. President?" said Blandish in a louder-than-usual voice.
"Yes," said the President, brought back to the present. He glanced quickly at his watch, then rose to escort Blandish to the door of the Oval Office.
"There is still one thing I don't get. Let's go back to the part where the bank lent the guy $1,000 worth of this phony credit stuff. Sooner or later, the borrower will write a check, and it may end up in another bank. That bank will want real money. So the check will be returned to the bank that originally made the loan and be subtracted from its reserves, right?"
"Right," said Blandish. "But you have to remember that one bank's loans become another bank's deposits. When the second bank received the borrower's check, it credited the depositor's account, then put it in its reserve to be cleared through the Fed.
"Meanwhile, if this second bank also happened to be lending, some of its checks might end up in the first bank, thereby adding to its deposits and reserves. The moral of the story is: the individual bank normally has more credit to lend when other banks are also lending."
"But what would happen if only one bank was making loans?" asked the President.
"It would be very dangerous," said Blandish. "Its reserve would be drawn down, and it would either have to increase its assets or stop making loans. It is only when many banks are extending credit that there can be a rapid growth in bank deposits."
"So," said the President, "what it all boils down to is that Ma Ma Fed's reserve requirements tend to encourage all member banks to expand these credit things at approximately the same rate."
"In a manner of speaking, yes," said Blandish.
"So little num-num can't extend too much credit and upset the apple cart."
"Oh, no, he still can," said Blandish, "but it's a lot harder now because Ma Ma…I mean, because the Federal Reserve System is always there to help clean up."
The President shook Blandish's hand. "I enjoyed our little chat. And you can be sure I understand now where inflation comes from."
"From higher prices," quipped Blandish, who always liked to end a conversation on a pleasant note.
"What?" said the President, who hated smartalecks.
"I know, I know," said Blandish hastily. "You think inflation is laid by Ma Ma Leghorn and her little brood."
"You can bet your last farkleberry on that!" said the President, easing him out the door.
Limp with the futility of it all, Blandish trudged the hushed corridor away from the Oval Office.
Ma Ma Leghorn, indeed! he thought to himself. What will this incredible blockhead think of next?
Eric Way is a free-lance corporate speech writer with a background in economics.
This article originally appeared in print under the headline "The Great Money Hoodwink, II".