Centuries before the United States was founded, banks had usurped the power to create money; they simply did it and no one stopped them. The story is told of goldsmiths accepting gold for safekeeping and issuing receipts that people then exchanged as money. According to common lore the goldsmiths soon realized they could get away with issuing more receipts than there was gold because people seldom came to reclaim their gold. Out of this, the practice of fractional reserve banking was developed. Whether that’s exactly how it happened or not, it has been common practice for centuries for banks to create money by issuing IOUs. (See How is Money Created Today? for a description of the current money creation process).
When the United States was founded, the U.S. Constitution, in Article 1, Section 8, gave Congress the power “To coin money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” However, it left open a gaping hole with regard to the role of banking and who should have the power to extend credit—the government or private interests. Should government depend upon borrowing money or be the sole authorized creator of it? How much power should private banks have?
Thomas Jefferson and Alexander Hamilton famously argued over what sort of banking system the U.S. should have, with Hamilton advocating for the establishment of a national bank (modeled after the Bank of England) and Jefferson wanting the power to create a bank reserved for the States. What was apparently not included in the dispute was whether banks should have the power to create money at all.
The nature of government-issued money was also a subject of debate. Should money be dependent upon the value of a commodity such as gold or silver, or should its value be solely defined by law, that is by fiat. With some notable exceptions such as Lincoln’s highly successful Greenbacks used to fund the Civil War effort, the commodity role predominated. The gold standard in the U.S. required that the cash issued by the government was redeemable in gold or silver kept by the U.S. Treasury. This severely limited the amount of cash the government could issue.
The banks, meanwhile, were limited only by whatever reserve requirements were in place. Early state-chartered banks had no reserve requirements at all. Various changes to reserve requirements and to the legal relationship between banks and the government were instituted and fought about over the decades, but never were the banks prohibited from creating money.
Economic booms and busts prevailed throughout the eighteenth and nineteenth centuries. This eventually prompted a study of the U.S. money and banking systems, which resulted in the passage of the Federal Reserve Act in 1913. Rather than address the root causes of the instability, this legislation established the Federal Reserve System as a privately owned central bank with twelve regional banks serving several thousand member banks, also privately owned. This reorganization sanctioned and institutionalized the power of private banks to create money. It also provided for cash to be issued as Federal Reserve Notes (IOUs from the Federal Reserve Bank) rather than U.S. dollars.
The crash of 1929 followed by the Great Depression made it painfully obvious that the Federal Reserve Act had not solved the problems with banking and money.
In the early 1930s a collection of banking reforms was put forth by a group of economists at the University of Chicago. This plan, referred to as The Chicago Plan, actually did address the problems associated with bank creation of money. It recommended an abolition of the practice of Fractional Reserve banking, and a change to a 100% reserve requirement. Though it was supported by over 235 noted economists from 157 universities and colleges, it was never made law.
Instead, tweaks were made to the existing legislation, such as providing FDIC deposit insurance in 1933. This was still missing the root of the problem, and in fact would be completely unnecessary under a stable money system. Rampant instability and injustice remained—and still remain—the norm.
The U.S. eventually dropped the gold standard, which released some of the restriction on the creation of cash. However it did nothing to mitigate the effects of allowing private banks to create money through interest-bearing debt, with lending decisions based on their own motives and independent of concern for the welfare of the economy and the public.
It doesn’t have to go on like this. The Alliance For Just Money is working to change the money system to something that works for all the people, not just the banks. The Just Money Solution
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