Marx Smiles Down at the Global Monetary Crack-Up

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In the earliest days of the Republic, the framers gave grave and solemn attention to the role of money and finance. The vast majority despised the government issuance of paper money, but noticeably did not expressly forbid the federal government from its use. In Federalist No. 44, James Madison wrote that while paper money was abhorrent, or as he said, "The loss which America has sustained since the peace, from the pestilent effects of paper money on the necessary confidence between man and man", it was rather the individual States that were to be dispelled of any appeal toward fiat:

"Had every State a right to regulate the value of its coin, there might be as many different currencies as States, and thus the intercourse among them would be impeded; retrospective alterations in its value might be made, and thus the citizens of other States be injured, and animosities be kindled among the States themselves...No one of these mischiefs is less incident to a power in the States to emit paper money, than to coin gold or silver. The power to make anything but gold and silver a tender in payment of debts, is withdrawn from the States, on the same principle with that of issuing a paper currency."

From this and other works we can deduce rather easily that though the Framers were quite against paper money as a system, they did not want to abolish the possibility of its use in an emergency, such as was done during the Revolution. Looking back on the Continental dollar episode it is quite easy to see why that was the case, since it was properly viewed that using paper dollars as tender amounted to appropriation of property without fair value recompense. Money, true money, was property and not some element of finance to be figured out via mathematical table of conversion, it was a physical quantity that fell under the same laws as your house or your horse.

Much the same system remained in place throughout the next century until the existential emergency of the Civil War. Paying for the constant war escalation, required so by initially and disastrously underestimating the South's militia arrangements and leadership, sped directly toward the next great paper money experiment. "Greenbacks" were issued and behaved as all paper had done in history - they devalued over time. It became a legal issue of property after the war had concluded, though it was not as settled as some had imagined. Reconstruction brought with it a new legal framework, particularly under the three new constitutional amendments.

The specificity with which paper money would withstand scrutiny derived from a much earlier argument over the Second Bank of the United States. The State of Maryland had argued in 1819 that it had the sole right to regulate money in its jurisdiction, thereby placing a tax on all notes not issued in Maryland, including those of the Second Bank.

The Supreme Court case McCulloch v. Maryland ended up defining federal government power for most of the modern age. The issue of the Second Bank's existence was used in evidence against federal power, as the government had no ability expressly identified in the Constitution to charter such a corporation. Chief Justice Marshall disagreed, and set forth the modern power precedent:

"The power of creating a corporation is not like the power of making war, or levying taxes, or of regulating commerce, a great substantive and independent power, which cannot be implied as incidental to other powers, or used as a means of executing them. It is never the end for which other powers are exercised, but a means by which other objects are accomplished."

So just as the Supreme Court ruled that the Second Bank was a means to achieve a legitimate government interest, so would become paper money in the Legal Tender cases in the early period of Reconstruction. One of the most contentious of those cases, Hepburn v. Griswold, was eventually used to uphold the lawfulness of legal tender paper.

On June 20, 1860, four months before Abraham Lincoln's election to president, Mrs. Hepburn of Kentucky made a promissory note of future payment to Henry Griswold, also of Kentucky, in the amount of $11,250 to be collected by February 20, 1862. Between the time of the original "investment" in 1860 and the maturity, the South seceded from the Union, including Kentucky, and war was enjoined. But Greenbacks were not authorized nor issued until five days after the maturity of Henry Griswold's investment. In his mind, he was due $11,250 in gold, silver or other form of verified claim on such property.

In authorizing federal paper money for the war, however, Congress specifically mandated legal tender status including the language that is stamped upon Federal Reserve Notes to this day, "...shall also be lawful money and a legal tender in payment of all debts, public and private, with the United States..."

Mrs. Hepburn had failed to make good on her obligation, starting an interest clock to be added to the principal amount due. Finally, in March 1864, with Kentucky firmly back within the grasp of Union authority, Mrs. Hepburn paid Mr. Griswold $12,720 in United States notes, Greenbacks. Griswold sued, and the sum was paid into the Louisville Chancery Court, which eventually adjudicated in favor of Mrs. Hepburn that the debt had been satisfied. Griswold appealed and the Court of Errors (a name that no doubt should have remained through to recent history) of Kentucky remanded the case back to Chancery Court with "instructions to enter a contrary judgment."

The case was appealed to the US Supreme Court in 1869, with Chief Justice Salmon P. Chase, the very Secretary of the Treasury who had worked to establish Greenbacks and legal tender status, delivering the majority opinion.

"Contracts for the payment of money, made before the act of 1862, had reference to coined money, and could not be discharged, unless by consent, otherwise than by tender of the sum due in coin. Every such contract, therefore, was in legal import a contract for the payment of coin.

"There is a well known law of currency that notes or promises to pay, unless made conveniently and promptly convertible into coin at the will of the holder, can never, except under unusual and abnormal conditions, be at par in circulation with coin. It is an equally well known law that depreciation of notes must increase with the increase of the quantity put in circulation and the diminution of confidence in the ability or disposition to redeem."

Chief Justice Chase even noted that United States notes had depreciated by July 1864 to an amount of about $2.85 in notes for every $1 in gold. The Court sided with Griswold in that even the federal government could not overturn private contracts without "just compensation", which Greenbacks at face value clearly were not. The case and the precedent, however, were overturned in 1871 by the majority decision in the Know v. Lee which held, as established through McCulloch v. Maryland, that legal tender was not an end itself but a means to an end, the conduct of the Civil War, and thus perfectly acceptable.

That raises an economic question as well as legal, whether such knowledge of the legality of tendering discounted or debased notes as full payment would reduce the willingness of the Henry Griswolds of America to engage in such financial investment. It certainly introduces and embeds the concept of financial risk as a significant component within the calculus of monetary circulation, which is in addition to, not part of, any prior views on credit risk or the risk of default and receiving the return of property. That latter risk, of property, is of bankruptcy and the like, while the former is now common in the financial concept of the rate of return in compensation for just this legal arrangement - debasement as a constant factor in the settlement of debts.

The latter half of the 19th century in economics was spent in exactly that spirit. This is not to say that financial calculations were wholly absent prior to the Civil War period and Legal Tender cases, but there is a magnitude of difference under the arrangements before and after. One strain of economics began to count the traditional arranged affairs of money as a form of social abuse, and thus sought a means by which to compel circulation under much the same cover as "provided" by McCulloch.

These were the Fabians and others, those dedicated to the idea of socialist equality. The primary economic arrangement that took up the vast majority of their time was what eventually came to be known as underconsumption. The rich and wealthy had money in their possession, sitting idle and thus condemning the economic circulatory system to underuse. If the rich man could be compelled by force to part with his hoard of savings, the economy would grow more quickly and fully through the spread of consumption. Perhaps the first real expression of that, at least in the Anglosphere, came in the form of the People's Budget in 1909 in Great Britain - where the wealthy land owners were to be taxed to fund entitlement payments to the poor.

In America, underconsumption took hold in various ways, but particularly Herbert Hoover and eventually FDR. The theory of underconsumption also provided the intellectual foundation for John Maynard Keynes and his eventual theory of economic circulation that is dominant today on both sides of the conventional political divide.

But this entire strain of economic thought rests upon the idea of compulsion to circulation. It does little to account for investment as an alternate means, and completely overrides the idea of risk. The hoard of money, as it were, was mobilized and returned (circulated) not through notions of inequality or anything of the kind, but rather fair assumptions about rates of return. In the case of Henry Griswold, he discounted in the middle of 1860 that the return sum of $11,250 by 1862 was enough profit for him to mobilize his savings to be used in the form of whatever Mrs. Hepburn sought to do with it. It entered the economy thusly.

If Griswold had known then what he found out by 1864 when Hepburn finally paid up in paper notes, it is highly likely that he would have kept his money to himself and never engaged in economic trade with Mrs. Hepburn. Should the government then induce him to do so via taxation and the circuitous route to some entitlement payment to another individual so that consumption may take place then?

What stands in opposition is both the means by which activity in the economy shall take place and the framework under which it will do so. In the free market approach, the savings of those that possess such property will engage in the economy when the rate of return is sufficient to rate enough potential indemnification or recourse against credit risk and now financial risk of doing so. The free exchange of such performs a high degree of intermediation that benefits the structure of future growth where blind consumption simply cannot. Discerning calculations with money offer insurance against engaging in too much wasteful actions and activity.

For the underconsumptionists, that simply isn't good enough. Prying money away from the judicious eye of the wealthy is to encourage growth through consumption - and in that manner the path to prosperity dawns via demand. There are more than enough willing uses for those savings further down the income ladder, as poverty apparently breeds no end to demand potential. But that is not really the issue, it is a diversion. The real problem is by which method does sustainable and healthy economic growth appear.

We see exactly this shortfall today in the conduct of central banking all over the world. The rate of return on "money" is abused to nothing, and money itself has lost all ties to property, instead being a means toward that one end - consumption. The further the rate of return, set copiously by "influencing" the systemic cost of risk, winds toward zero, the less economic advancement seems to be gained from the effort. This is not just true of the United States in this "recovery", it includes economic growth here going back to at least 1985, as well as the "lost" decades, now two and half of them, in Japan.

And it is further being put to the test in Europe, where the ECB has just rolled out the most prominent and significant negative interest rate in history. Apparently underconsumption, winding through modern neo-Keynesianism, has grown tired not just of the wealthy sitting idle of "otherwise useful" stores of cash, but now banks too. There is much rich irony in that observation, as it was the financial growth and domination of banks that was supposed to "free" the global economy from the dominion of the stingy money hoarders. The demand side demanded credit-financed consumption, through banking, and received it in no less than biblical proportion.

Now that it isn't good enough. The banks are now the hoarders and must be forced to lend so that underconsumption might again be defeated in such a manner. That is not just the intent of the negative deposit rate in Europe, but also QE here and in Japan (or was until the orthodoxy began to realize inflation wasn't what they thought). The idea is to reduce the rate of return so far as to make savings so unattractive they are mobilized. It is the echo of Fabianism and underconsumption glossed up in the modern cloak of mathematical statistics.

There is something powerful in the lengths to which policymakers go today to achieve an "aggregate demand" paradise. If it is not quite full circle, it is something very close. In the unalterable quest to create demand from nothing more than money, and especially that created out of nothing by those very banks' balance sheet capacity, the system's command and control has turned its guns on itself. Henry Griswold is not the target anymore; it is the very bank that government "interest" used to change his property into finance.

Karl Marx held fast to the idea that capitalism would eventually implode under its own weight. That was always bunk because he, much like the underconsumptionists, discounted the role of savings and investment in fostering innovation - and thus innovation feeding consumption rather than money and credit doing so. We may fast be approaching the point at which Marx is proven partially correct, but not in relation to capitalism, rather in the monetarist bastardization of it. Policymakers are attempting the system consume itself to the point of coercing exactly that.

The nature of that beast was written in the opinion of Chief Justice Marshall who stood out the idea that as long as it is a means to a government end, all shall be allowed. If you think the hoarding of savings is a direct violation of society's interest toward consumption and equality, what care is there for a natural and fair rate of return on savings and money? What is left when that inevitably fails, as there is a diminished capacity toward efficiency in monetary uses, as well as the impulse to productive innovation, is the ratchet effect - failure breeds more "societal interest" that must be coerced from someone or somewhere. Perhaps there is encouragement in that targets seem to be running short, but Japan has as yet continued to plug away at hoarding for going on twenty-five years. Outside of changing the system sooner rather than later, that is not encouraging, but importantly informative.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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