A few things about Allyn Young
He goes against economic orthodoxy. There are 3 dimensions where he is engaging with the economics.
- He disagrees we use money just because of the inconvenience of barter – money has always been there, ever since trade.
- He believes that money is key for growth, money is the fundamental factor in economic activity.
- He is also a critic of currency principle – there has to be more elasticity in the system.
There are 3 more dimensions where he engages with the outside world:
- He is opposed to Chartalist – the dollar bills have value is because of the power of the state.
- He is not an efficient markets guy, putting himself on the side against the speculators.
- Populists. He thinks we need central banks. He thinks gold standard is a good thing.
Civil War Finance
Government is fighting a foe and it has to mobilize as many resources as possible in order to win the war. They tax, have conscription, and sell bonds. The bond sales work like these balance sheets (also reducing purchasing power):
| Government Assets | Liabilities | Private Sector Assets | Liabilities | Banking system Assets | Liabilities |
| +Deposits, G | +Bonds | -Deposits, PS +Bonds | -Deposits, PS (debet) +Deposits, G (credit) |
The total deposits in banking system does not change, they are just changing the ownership of some deposits. If government can not sell bonds, it might try to sell directly to banking system, by taking a loan.
| Government Assets | Liabilities | Private Sector Assets | Liabilities | Banking system Assets | Liabilities |
| +Deposits, G -Deposits, G +Gold | +Loan | +Loan -Gold | +Deposits, G -Deposits, G |
The US went off the gold standard since Mr. Salmon P. Chase sucked all the gold into his own pockets.
Legal Tenders / Greenbacks
You can not get gold for this, you can just exchange it for another dollar bill. The US is off the gold standard, you are not allowed to refuse legal tenders as payment for a debt in the US.`
| Government Assets | Liabilities | Private Sector Assets | Liabilities | Banking system Assets | Liabilities |
| -War goods | +Legal tenders | -War goods +Legal tenders -Part of Legal tenders +Deposits | +Part of legal tenders | +Deposits |
Then legal tenders become the reserve of banking system. When someone is withdrawing their deposits, they are withdrawing deposits not in gold, but in legal tenders. Essentially what Salmon P. Chase did in the hierarchy of money, was to insert legal tender money in between gold and deposits. Legal tenders can only be used to buy domestic goods.
During the war the value of these legal tenders keep falling relative to gold. because these legal tenders are just adding purchasing power that did not exist before. The consequence of this is to depreciate the value of these legal tenders.
National Banking System
In 1863, Salmon P. Chase tries something else, he sold bonds (with low interest rate) and let the bank issue banknotes currency using the bonds as collateral. It is just as if the government had borrowed from the banking system by allowing the banking system to write its own notes – creating money. At the end of Civil War, that became the money supply.
| Government Assets | Liabilities | Private Sector Assets | Liabilities | Banking system Assets | Liabilities |
| +Deposits, G -Deposits, G +War goods | +Bond (low interest) | -War goods +Deposits, PS -Deposits, PS +Banknotes | +Bond (low interest) | +Deposits, G -Deposits, G +Deposits, PS -Deposits, PS +Banknotes |
The consequence of this was financial instability, which happened like this:
- Country farmer withdraw $50M cash from local banks
- Implies withdrawal of $50M from New York banks
- Calling in call-loans to speculators, which led to stock falls and interests rise.
- Raising reserves from London, which disrupted world gold market.
Federal Reserve System, Plan
The history of American central bank is a history of war finance. President Wilson is who got it through just in time for World War I. Young says there are, under the Fed Reserve System, 3 levels:
| Member banks | Main street bank, making loans by expanding their balance sheet, supporting business. They fear when deposits are withdrawn, they don’t have sufficient reserves to make payments. When they need to replenish their reserves, they can always get more from their local reserve banks, using loans as collateral. |
| Reserved banks | Can create reserves on their own balance sheet from thin air. |
| Federal reserve | Central bank. |
The balance sheets are roughly like this:
| Member bank Assets | Liabilities | Reserved bank Assets | Liabilities | Federal reserve Assets | Liabilities |
| +Loans +Deposits, FR | +Deposits +Discount Loans | +Discount Loans +Notes, FR | +Deposits, FR +Rediscount | +Rediscount | +Notes, FR |
“Notes, FR” is cash money, so the supply of cash also is elastic and can expand and contract to meet demand.
Federal Reserve System, Actual
Once the Fed was created, the U.S. went to war again. The Fed got involved not so much in the action planned, but financing another war. After the war, the Fed Reserve, reserve banks, even all member banks were stuffed full of treasury bills. This is not how the system was supposed to work. None of what has planned could happen, because all the banks are filled with treasury bills.
So instead, there is open market operations, which was invented by New York Fed, by Benjamin Strong in the 20’s. The importance of open market operations is a historical accident. It’s an accident that the Fed got stuffed with treasury bills, it was never supposed to lend to the government. The whole danger of central banking is legal tenders / greenbacks are in the minds of the framers of Fed Reserve.
We live in a hybrid system where central bank is partly a bankers’ bank, in times of crisis, it is a government bank. You could build a monetary theory (pure state money) that, at the root of everything, it is the state that is printing money, and everything is just a promise to that. Or you could build another monetary theory (pure private money) that government is making use of the private banking system. But the actual system is hybrid.
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For more on From National Banking System to Federal Reserve, please refer to the wonderful course here https://www.coursera.org/learn/money-banking
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