The musty old document that supposedly governs this country, the Constitution of the United States put into practice way back in 1789, makes no provision for the governmental institution that has proven the most influential of our time: the Federal Reserve. About the only clause in the whole multi-page document that might even remotely pertain to authorizing a Federal Reserve is this expression from Article 1, Section 8:
“The Congress shall have Power To….coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures….”
That’s it. You can search the document up and down for lines referring to the monetary authority of the country, and all that will turn up is stuff on Letters of Marque, Presidential Electors, and permission to tax slave imports up to $10 per.
It is not the case that banking, much less “central banking”—or paper money for that matter—did not exist 225 years ago, such that the Founders could have authorized a Fed had they ever heard of such a thing. Paper money was a “warehouse receipt” for gold or silver coin (or bullion) that an institution kept because it was more convenient for the owner of the money to conduct affairs without hauling precious metals around on one’s person.
By way of analogy: when you go to the symphony, you check your heavy coat at the window and get a little chit in return. You settle into your seat sans bulky outerwear, take in the music for a few hours, glide around effortlessly (unencumbered by Gogolian overcoat) during intermission, and when all is done give in the chit and get the outerwear back.
This is what paper money was in the old days: a chit. It was also tradable, in that whoever had the receipt could claim the underlying asset on hitting the warehouse.
European and soon enough American banking not only had money warehouses but also “clearinghouses,” which kept records of the warehouses’ obligations and helped certain warehouses that had over-issued receipts to get back to par by arranging for others lend to them. In fact, the clearinghouse system was so well developed and experienced by the early 20th century that the Federal Reserve is usefully understood as an attempt to ape—to monopolize—this very successful innovation in private banking in this country.
The usual justification we get from the defenders of the Fed is that “modern times” require this governmental octopus, its stacks of Ph.D.’s in economics, and its gross plenary powers. Otherwise the post-industrial economy couldn’t function (or rather muddle along at a 1.8% rate of growth). Yet the prehistory of the Fed suggests that government had become jealous of the ability of the private banking system to solve its own problems. Then in defiance of any real Constitutional grounding, it nationalized the clearinghouse/warehouse system.
Milton Freidman’s most luminous student, it is now clear, is the quondam University of Georgia economist Richard H. Timberlake, whose histories of the monetary system up to and including the stunning Constitutional Money: A Review of the Supreme Court’s Monetary Decisions (2013) have made these points clear as day. We have central banking not because the private system was at a loss during periodic panics and crises, and certainly not because economic growth needed a Fed (economic growth was huge prior to the era of the Fed), but because the government in its dumbness willed it.
The Fed got going in the decades after its founding in 1913 under the auspices of a Supreme Court dominated by its most stentorian member, Justice Oliver Wendell Holmes II. Holmes was the originator of the doctrine of “legal realism,” whereby Constitutional niceties give way to hardheaded analysis of what complex modern society actually needs. Advanced America needed a Fed, so it got one.
A more sophisticated form of legal realism, one say informed by the field that congealed under the title of “public choice” economics, would have revealed that what had occurred by the 20th century was that the private economy’s immense success through the industrial revolution had bred jealousy on the part of government. Government wanted the credit for economic growth, or the damping of economic growth. The one intolerable choice was that of the status quo: a society succeeding magnificently in the absence of governmental input.
Oliver Wendell Holmes II’s most famous line came from a case in the 1920s where the justice said, as he blessed not monetary but physiological sterilization of the mentally handicapped, “three generations of imbeciles are enough.” In his own case, clearly it was two generations. It is time to blow the phony legal cover that has enabled the Fed all these years and reclaim the traditions embedded in this country’s history for a private monetary system that befits its traditions of growth, problem-solving, and prosperity.
This essay first appeared in Forbes and is republished here with gracious permission of the author.
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