Story Stream
recent articles

At root of the petrodollar error, that there is a petrodollar, is the very idea that governments monopolize money. You hear the claim repeated incessantly, a power, perhaps the power that authorities took on and will never, ever relinquish. Therefore, when Bretton Woods supposedly broke down in August 1971, it was for the government to overcome its deficiencies and move forward.

It’s understandable why some would incorrectly claim the US had transitioned from a gold-backed government currency to one tied to crude oil; the petrodollar. That the latter would also lead to foreign ownership of US federal government debt makes the theory that much sexier, perhaps more plausible than your typically conspiracy.

Actual monetary history is shrouded in shadows, mostly on purpose, therefore the mistake(s).

As most people know, and those who speak about this petrodollar idea know very well, the big change in monetary affairs actually took place long before the seventies, way back on April 5, 1933. This was Executive Order 6102, the infamous confiscation of private holdings of gold money. Specie was outlawed.

From here the misconception was born; that FDR’s overreaching administration prohibited private commodity money, as it did, replacing that private money with government-printed currency in the form of Federal Reserve Notes. Thereby, forever forward, having violated the sacred, historic gold clause obligation in order to gain monopoly control over the nation’s money.

Not true.

While Executive Order 6102 did, indeed, confiscate private commodity money, it hardly dented the nature of America’s full and complete monetary system. This is the part always left out from the conventional tale; commodity money had already been circumvented and superseded by another form of private money long before then, and one most people are aware of, if not completely consciously.

Call it fractional reserve lending if you will, in some ways the term misses the point. The traditional idea of fractional reserves places emphasis on the reserves rather than the fraction; and just who is doing the fractioning.

By the turn of the last century, the use of hand-to-hand currency – whether in specie, such as silver coin, or paper primarily bank notes (which had to be backed by US Treasury obligations, so nothing new by 1973) - had already begun to die out. One Federal Reserve Bank of Atlanta study (from 2008) recounting the global history of checks noted the following about those early, pre-Fed days:

“Kinley (1910, 200) estimates the contemporary share of checks in business-to-business transactions, or wholesale trade, at 90 percent. The success of the check payment system was all the more remarkable for its decentralization: Each bank was connected to this system only through correspondents of its own choosing.”

Throughout the 1910’s into the 1920’s, the practice only spread more to the point that middle class Americans were more frequently writing checks, too, not just the wealthy or the wholesaler.

What made this form of money into money was how presentation of a check became so commonplace because it was treated as good as gold; that is, once this ad hoc correspondent system of interbank deposit networks cleared these pieces of paper, it functioned in every respect as if gold or Federal Reserve Notes had been given over by the payor to the payee.

All it required was some standardized, somewhat sophisticated bookkeeping and a healthy dose of telecommunication innovation to make as if gold traversed the country at the speed of electricity.

In most early cases, this was easily done, too, where regional correspondent networks meant oftentimes check writer and check casher accessed that same network. And even when they didn’t, financial institutions charged a fee for any “irregular” checks which users gladly paid so that commerce could easily spread far beyond strictly regional borders.

With hand-to-hand currency falling far out of favor, other forms of payments processing developed, too, including interbank correspondent settlement methods like federal funds. Wire transfers came to be used more frequently, particularly with high-volume, high-dollar payments transactions.

Even the Federal Reserve got involved, from its earliest days creating the pre-eminent interregional payments processing machine we still know today as Fedwire.

What was transacted across this growing web of book entry money wasn’t gold, nor was it Federal Reserve Notes. Rather, these were book entries of private ledger money maintained by the banking system.

On December 31, 1914, the Federal Reserve reported that its member banks held $739 million in various forms of “vault cash”; a mix of gold or silver coin along with physical cash such as bank notes (a tiny bit) or Federal Reserve Notes (mostly). In addition, banks also transacted with the Fed branches to the tune of $266 million of the central bank’s bank reserves, its own book entry account that is useful for the regulatory purposes of satisfying legal reserve requirements.

From those two items, system banks had created $8.3 billion in deposit liabilities, of which $1.9 billion were interbank correspondent liabilities. In other words, a simple fraction of $8.30 in deposit liabilities for every $1 of cash and bank reserves. Deposits to just cash, the multiplier was 11.2.

Fast forward to June 1929, the Fed reported system banks had only $433 million in vault cash to go along with $2.4 billion in bank reserves on top of which a staggering $35.9 billion in private bank deposit money had been created. That was $12.85 in deposits for every $1 in cash and bank reserves, but really a grotesque $82.83 in deposits for each dollar of actual cash.

The amount of private bank money that had been created up to October 1929 blew away both the level of private commodity or paper money in bank possession (in vaults) or held by the public outside the system.

And those bank reserves, controlled exclusively by the Federal Reserve, only contributed more to the problem once it arose. Not only had these convinced banks to depend so much on them rather than more prudently holding far greater private cash and commodity money, having so much less actual cash in hand to satisfy customer claims to convert their deposits left the entire system exposed to the implosion unleashed by Wall Street’s Black Tuesday reverse.

The fatal flaw with that hybrid wasn’t the commodity piece. But Economists convinced politicians that it had been; the shameful call to ban private “hoarding” which was eagerly, to some extent understandably taken up by the new dealings of the new administration (FDR on record saying about the gold clause that it couldn’t possibly get any worse anyway, so experiment he sure did).

What followed was therefore the extinction of private commodity money but now in favor of more exclusively private bank money – with only a small measure of government money in both Federal Reserve Notes the public would use less and less over time (more checks) to go along with the Fed’s bank reserves banks truly didn’t want nor depend upon.

Nowhere was this shift more evident in its earliest days than in 1937. Fearing inflation, the Fed raised reserve requirements because of the huge increase in bank reserves which had resulted from 1934’s dollar devaluation (the government paying more of its dollars for gold). The banking system rejected that inflationary interpretation, along with the Fed’s management of those bank reserves.

Member banks continued to manage their liquidity profiles not with vault cash in any form but rather liquid earning instruments especially US Treasuries. In other words, banks disregarded bank reserves to an extent understanding on a fundamental level the Fed could not be depended upon to act effectively in an emergency.

Therefore, it had been those assets which supported the private ledger bank money deposits basis. These actions in ’37 would lead to an accidental struggle for full-blown monetary control. Federal Reserve Bank of New York President George L. Harrison declared in an August 1937 private meeting with other FRBNY officials:

“…that we had a Federal Reserve System and Federal Reserve banks ready to make loans and that I thought it would be better the quicker the Board and perhaps some of the banks got out of the frame of mind that we must now always have excess reserves. I much preferred…to see the System function again as a System and to have the banks borrow and to show bills payable.”

Harrison argued that the basis for the post-1933 monetary hybrid should get shoved more toward the government money of bank reserves, therefore Fed monetary policy governing the fractional reserve into deposits as is so often today claimed and widely believed.

It did not happen; even Milton Friedman and Anna Schwartz had written in A Monetary History how there was good reason for it to go the opposite way:

“Throughout, the high level of the discount rate relative to market rates reinforced the banks’ reluctance (bred of their 1929-33 experience) to rely on borrowing from the Federal Reserve Banks for liquidity and led them instead to rely on cash reserves in excess of legal requirements and on short-term securities.” [emphasis added]

At such a crucial moment in this monetary history, on the one side George Harrison wished to put the Fed back into the center of the private bank money regime, tasking banks with begging from that Fed whenever and wherever deposits and cash grew out of sorts. The banking system, for very obvious reasons, as Friedman and Schwartz pointed out, decided instead to handle their own liquidity in their own way(s) regardless of the Fed.

What that meant in 1937 was first further calamity – and no one could blame private commodity money that time - merely reinforcing the direction toward private bank money away from Fed-centered government bank reserves. Harrison and others at the Fed had provoked a truly unnecessary backlash if only to end up proving their view wrong.

Furthermore, this – and Bretton Woods, believe it or not – merely set the world up for the next, logical step in monetary evolution. From the pre-Depression hybrid of private commodity money/private bank money, the system quite sympathetically, given the flaws in Bretton Woods along with the meddlesome tendencies of authorities worldwide to get everything wrong, ditched the hybrid model entirely.

The eurodollar would very quickly turn to a system of purely book entry, bank ledgers with no place (apart from certain regulatory impositions most-times easily circumvented) for the governments or tokens of any variety. No vaults, no cash, not really bank reserves, either, other than as a domestic nod to outmoded reserve requirements.

And it makes sense, from the private bank money perspective. If private vault cash was annoying to the point of becoming dangerous, like 1930, and bank reserves couldn’t be effective and dependable even for regulatory purposes, such as 1930 or 1937, just get rid of reserves in every form. Thus, the eurodollar as a reserve-less private bank money system.

The very same private system which (too) easily (thus, Great Inflation) spread around the globe long before 1971, already linked directly to other liquid stores of values like US Treasuries from its earlier precursor tendencies born out of depression necessities.

Executive Order 6102 had been a watershed event, but not in the way many perhaps most seem to think of it today. In many ways, it turned out the opposite. The world did not transition from private to public money in 1933, the confiscation of gold at that time merely sped up the conversion (pun intended) from the previous private mix between commodity and bank money toward more completely private but exclusively bank money.

While hardly anyone today appreciates these dramatic changes, especially in this era of the Volcker Myth, the public more than approves whether they know it or not. The use of ledgers, nowadays in electronic format, had begun to proliferate even before the internet was fully developed.

According to the Atlanta Fed, the use of checks peaked all the way back in 1995. Private interbank ledger money, however, to this day remains largely the same in principle even if now digital rather than paper. Does this perhaps offer a solution to the current predicament?

To clean things up from the way they really went after 1933, as well as perhaps finally fixing the real monetary errors in bank money revealed in 2008, the next evolutionary step beckons. It isn’t CBDC’s, nor central banks at all since they’ve been left out of the mix for a long time already. We just keep money private and in digital book entry, as it is, though this time we put the banks in the same spot as the government.

Outside petulantly looking in.

Thanks to the eurodollar, for all its massive flaws, it got us partway back toward truly decentralized potential by demonstrating what can be done and having the public enthusiastically go along with the format. Moving ahead rather than behind, reserve-less ledger money really has no need for either banks or governments and most people wouldn’t really perceive a single difference in function.

They should and, in my view, likely would notice so much better (long run) results. No need to shoehorn oil into a mix where it didn’t and doesn’t belong, nor necessarily a government-led Bretton Woods revival which could only ever be chock full of mistakes, misconceptions, and zero sense of history like the real plumbing. 

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

Show comments Hide Comments