Constructive Steps Toward Free Markets in Currency

By: Michael Rozeff | Sun, Jul 17, 2011
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Economically, it's not hard for America to transition to free markets in currency without disrupting the economy. I already outlined steps in Chapter 13 of my free e-book The U.S. Constitution and Money. Politically, it's extremely hard.

The most likely route to free markets in currency is through international competition. Some foreign state or states will realize the benefits that they will gain by using gold as currency rather than their own credits or those of the U.S. (the dollar). They will provide low-cost facilities by which anyone anywhere in the world can either get bullion coined or can get secure warehouse receipts for stored bullion. They will encourage their own citizens to use gold as money. They will conduct their own transactions in gold. Their economies will benefit from a stable currency, stable prices, low interest rates, and low uncertainty. They will attract investment capital from all over the world. They will become financial centers. Companies involved in international trade or who have foreign operations will find it in their interest to switch to gold pricing. As the U.S. and other states see their tax bases shrink as capital (human and financial) leaves, they will take a greater interest in gold. Political pressures on their governments to compete in gold will rise. The rest of the world will find that their economies cannot keep up unless they too switch to gold.

On the other hand, if the major powers on the planet extend or deepen their existing monetary cartel into a monolithic entity that controls a world paper currency, then the order of force in currency goes international. The problems become even more severe. How is one to overturn a worldwide order of force?

Even if international competition is the most likely path, it's not the only one. If the U.S. performs badly enough for an extended period, there might arise political pressures for sounder currencies from that source.

It's worthwhile to point out what's involved in making such a transition. It's helpful to know what various changes in the law mean, if they were adopted, and it's helpful to understand how the present laws bind us and tie us down. Hence, this article.

Where did our current banking and currency laws come from? Who did this? Who made us slaves? Who took away our freedom? Who constructed the order of force in currency? My view is that this was and is a continuing joint process of the government with many Americans over many years. The government took away freedoms and "we" (meaning unnamed coalitions of past and present Americans) willingly gave up freedoms. Taxes are theft and "we" fashioned our own bonds.

The government could not grow large and do what we wanted it to do unless it was able to lay hands on our wealth and incomes. Controlling the currency is an important component in the taxing machinery. Like many such components within the order of force, its roots lie in the distant past. One such precedent is this:

"Created as a bureau of the U.S. Department of the Treasury by the National Currency Act of February 25, 1863, the Office of the Comptroller of the Currency (OCC) was charged with responsibility for organizing and administering a system of nationally chartered banks and a uniform national currency."

The North enacted this and other financial legislation, such as issuing legal tender greenbacks, in order to secure financing to fight the South in the War Between the States.

Here we are almost 150 years later with a greenback-style legal tender fiat currency issued and manipulated by a loosely-controlled captive finance subsidiary of the U.S. government called the Federal Reserve in conjunction with the successor fractional-reserve banks to the nationally chartered banks. Here we are with a uniform national currency.

Here we are with a highly-stressed, unjust and unstable financial system that is still working to support government's wars, only now it also supports a welfare state that is also a regulatory state and a police state. And here we are with an indefinitely-long stagnating economy.

It's not going to get any better unless we change direction, and the only possible change for the better is away from the order of force and to the free market order. Do not ever think that the basic choices are complex or that we need rocket science to penetrate what is upon us. It's very simple. It's force vs. freedom. A legislated paper or fiat uniform national currency is force. An international paper or fiat currency is even deadlier force. When a government, domestic or international, organizes and administers a system of banks, that is force. That is not freedom.

What's complex is that all change is political. It all involves changing laws. In a way, that too is simple: Elect people who will change the laws. There's the rub. Try changing the hearts, minds, and understandings of millions of voters who compose the "we" that willingly give up their freedoms and ours in the bargain. And if an international government arises, elections will have so little relation to the control of government that, hard as it is to believe, they will be even more meaningless than they now are.

As we say in science when we confront great difficulties, let us plow on. So, if we were to decide to move away from the order of force and to the free market order in currency, if this were politically feasible, how might we do it ideally?

Let us arrange a transition that is as fair and painless as we can conceive, a transition that keeps disruption down. How we order our moves is important. We cannot suddenly end the existing currency and payments system with nothing to replace it. Any proposals that create a sudden stop should be avoided. Certain steps should appear at the end of the transition or else they'd be disruptive. There are other steps that foster a gradual adjustment and introduction of new currencies. They can be done first.

Consider the transition to occupy three phases. In phase 1, we create conditions in which the alternative currencies can be brought online through natural economic forces. We create opportunities. Alternative currencies are allowed to arise. New banking laws come into being. In phase 2, the new currencies compete with the existing currency. New payments systems are created and/or existing systems adapted to the new currencies. The old currency and banking systems that use it have a chance to adapt to the new laws that govern them. In phase 3, we end the props of power that support the old currency. We remove the privileges of the old monopoly currency. We end the Federal Reserve as a government-privileged institution. We end the legal tender status of the old paper dollar represented by the Federal Reserve Note.

In this dream, the process takes about two years. The government publicizes the goals and the steps again and again. We somehow find a way to prevent lawsuits from delaying and derailing the process.

The rest of this article deals with moves that can be made in phase 1. We begin with progressive steps that can and should be enacted without delay and that cause no disorder at all. There is no excuse for opposing them. First comes a cluster of steps that involve gold and silver.

End federal and state taxation of gold and silver. The tax law heavily punishes exchanges that use silver and gold by taxing them as "collectibles." They cannot be candidates for currency under this condition. All taxes of any kind on the exchange of silver and gold for any other currency or as a currency or on the purchase or sale of silver and gold need to be entirely eliminated. No other action involving these metals will have a chance to take hold as long as gold and silver are taxed whenever they change hands.

Since gold and silver are a major currency option in free markets, taxation of transactions in them must be removed. Public official who are against this are unquestionably against a free market in currency. If they won't take this first step that removes no central bank privileges, they are obstructionists who should not be elected or re-elected.

Taxation of gold and silver prevents them from being used as legal tender by the states, and the Constitution clearly says that nothing but gold and silver shall be made legal tender by the states. Similarly, the only legal tender that the federal government can declare is also gold and silver. Public officials who vote to tax gold and silver dealings are therefore going directly against the Constitution.

With gold and silver transactions no longer taxed, it becomes possible for entrepreneurs to set up payments systems involving gold and silver that compete with Federal Reserve Notes (FRNs). Electronic exchanges with e-gold and e-silver (gold and silver backed electronic warehouse certificates) become feasible. Currency units that refer to weights and measures can arise that carry names like goldgram.

Currencies based on other materials and baskets of materials are feasible, but if they are subject to taxes, then these possibilities vanish. Therefore, no exchanges that involve exchanges of one kind of currency for another should be subject to taxation within or among the states. This leaves standing the usual state sales taxes on goods and services. Furthermore, companies that develop and deliver currency services cannot be discriminated against in the tax code.

Dr. Edwin Vieira, Jr. has done excellent work in seeking restoration of gold and silver currencies at the state level. Removal of taxes on these metals is essential or else that work cannot succeed.

Enable the legal use of privately-minted gold, silver, or other metal coins as currency. At present, the law forbids their use in no uncertain terms (see here):

"Whoever, except as authorized by law, makes or utters or passes, or attempts to utter or pass, any coins of gold or silver or other metal, or alloys of metals, intended for use as current money, whether in the resemblance of coins of the United States or of foreign countries, or of original design, shall be fined under this title or imprisoned not more than five years, or both."

It is truly astonishing to find such a statute in a country that prides itself on being free. The only law that is needed on private coins is one that forbids counterfeiting, fraud, and misrepresentation of a coin's metal content, no matter whether foreign or domestic.

Prof. Antal E. Fekete has proposed opening the U.S. mint to unlimited coinage of gold and silver. Congress is now reneging on this constitutional power. This means that Americans could bring bullion to the mint and exchange it for official U.S. coins at no charge. This should definitely be done.

It is impossible and unnecessary to maintain a fixed ratio of gold and silver, as our bad experiences with bimetallism should have taught us. There are two options. One is to define the dollar as a fixed weight of gold, since it has a more stable value than silver, and place no dollar denominations on silver coins but instead weight denominations. The other is to abandon the term dollar and simply mint coins in weight denominations. Prices could be quoted in terms of grams of gold or some conventional name.

These steps that allow minting of coins help to return the supply of metal money to the public, that is, to the unhampered free market. Completion of this requires that the government return the gold stock of the U.S. to Americans, but that should be done in phase 3. If this is done suddenly in phase 1, it creates large uncertainty in the value of the paper dollar.

None of these gold and silver actions directly use force against FRNs. They create the opportunity for alternative currencies that compete with FRNs.

Banking law now discriminates against gold and silver in favor of paper money issues. The solution is straightforward. In phase 1, the law should distinguish and require the legal separation of two kinds of institutions: safety deposit (or money warehouse) and risky deposit (or bank).

The safety deposit institution stores assets deposited with it and provides warehouse receipts for them; it makes no loans. It might provide negotiable receipts, or it might provide checking accounts for the deposits or it might provide e-transfers. Therefore, its only other possible financial operations are to clear transactions among its customers. If people wish to keep their money in their own name stored by a company, the money warehouse is a possible choice. Private insurance companies could probably arise to insure against loss. The company could buy such insurance. Government-mandated deposit insurance of bank deposits can be eliminated. The closest competitors to the money warehouses are home or self-storage and money market funds. The latter do not hold money at all, except incidental sums. They invest money in short-term credit instruments that conventionally are termed money market instruments.

The other type of institution is called a bank or risky deposit institution. The terms of deposits should be clearly defined as to the rights of depositors to redeem or exchange deposits for money and what constitutes a bank's defaulting on the obligation. Whether or not these deposits become media of exchange depends on the market, not on force.

To understand how a risky deposit bank operates, consider a mortgage loan. The mortgagee issues a promise to pay and becomes a debtor. Collateral for the debt is the property. The bank as creditor buys this mortgage loan and the mortgagee sells it. At the same time, the bank acts as a debtor by issuing a promise to pay money to the mortgagee on certain terms. (This loan is called by the confusing name of "deposit".) The mortgagee buys this loan (or deposit) and the bank sells it. The terms of this loan usually allow the buyer to redeem it to obtain money or put the loan to the bank in exchange for money. Thus, the bank buys a credit (the mortgage loan on the mortgagee's credit or promise to pay) and sells a credit (a loan convertible into money on its own credit or promise to pay). The bank profits when it pays less for the credit it buys than what it pays for the credit it sells. That happens when the interest rate on the credit it buys (the mortgage) exceeds the interest rate on the credit it sells (the deposit loan), and when all the loan terms are fulfilled.

Although the banking, payment, and clearing systems are all wedded to FRNs, we are very fortunate to have computerized systems and people with the technical knowhow to integrate several currencies into these systems. This is already done with respect to transactions that involve foreign currencies. It can be extended to alternative domestic currencies that also have rates of exchange among them.

There are two main clearinghouse operators: the Federal Reserve Banks (60% of the market) and the private Electronic Payments Network (40% of the market). We rely heavily on the clearing of the Federal Reserve Banks. We do not want to destroy that capital, nor do they. It is a profitable operation.

The Federal Reserve Banks will know that the FED's privileges on their FRNs will end within 2 years. They will know that they are going to become private banks. They will want to maintain their clearing operations. They will have an incentive to incorporate alternative currencies, especially gold, into their systems because when the U.S. government goes completely to gold, or when gold vastly diminishes the importance of the paper dollar, these banks are going to be scrambling for a viable business model. The district clearing operations can be spun off, either singly or in groups or in one company depending on how their operations mesh. This should be done to give them the appropriate profit incentives by separating them from the other very different FED operation which is bank supervision.

Possibly, a separate article will outline how to end the FED, but if not much of it is already available in my free e-book The U.S. Constitution and Money.

There is nothing to fear in the economics of allowing alternative currencies or reforming the banking system. There is much to fear in the politics. Since the government is the organization that changes the laws, politics enter. Forces will emerge constantly to maintain the order of force in currency. They will seek to reverse progress toward alternative currencies and prevent free markets in currency. Every asset of control will be thrown into a war of words to discredit gold or any other currency. Failing that, attempts will be made to co-opt gold into the existing paper system so as to perpetuate it. Politics is warfare by other means, namely, control over law-making.

Ending taxation of transactions in gold and silver is the first line in the sand. It causes no disruption to the system in any way. That is a clear line by which voters can tell who is with them and who is against them on the currency issue. This should be introduced in a separate bill in Congress. It should not be combined with any other measures, such as ending the legal tender status of FRNs. Before the latter is enacted, there should be alternative currencies and systems in place. People should have had a chance to adapt to them. Companies should have had a chance to react and enter markets. The competition alone is going to create serious pressure on the value of the dollar. A sudden stop probably would create so much disorder that it would discredit free markets. Congressional votes based on the expectation of that outcome are likely, so that if ending the legal tender status of FRNs is combined with the taxation issue, the line in the sand is erased.

Let's give Congressmen a clear choice on a measure that causes zero disruption, which is ending taxation of gold and silver transactions, so that we find out who favors free markets in currency and who favors the order of force in currency.

 


 

Author: Michael Rozeff

Michael S. Rozeff
Professor Emeritus
SUNY at Buffalo - Department of Financial & Managerial Economics
Department of Finance and Managerial Economics
Buffalo, NY 14260
United States

Michael S. Rozeff

Michael S. Rozeff is a retired Professor of Finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire.

Copyright 2010-2012 © Michael S. Rozeff

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