Showing posts with label federal reserve. Show all posts
Showing posts with label federal reserve. Show all posts

Thursday, 5 July 2018

Fractional-reserve banking

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“” As a model of how money is actually created, it is 'neat, plausible, and wrong.' The fallacies in the model were first identified by practical experience, and then empirical research.
—Steve Keen[1]
Fractional-reserve banking is a relatively simple but wrong way of describing the banking system. As always with bad economics, it is popular partly because older academics have a vested interest in defending the idea, but also because it serves a useful political purpose for plutocrats. Namely, it basically denies that banks control the money supply of the modern economy. This allows the rich to place the onus of controlling the money supply upon governments, specifically by cutting expenditure on the grounds that it creates inflation (it can, but it presently doesn't).
“” Banks do not, as too many textbooks still suggest, take deposits of existing money from savers and lend it out to borrowers: they create credit and money ex nihilo – extending a loan to the borrower and simultaneously crediting the borrower’s money account
—Lord Adair Turner, formerly the UK's chief financial regulator[2]
When they lend money, banks create money out of nothing. They can do so with no deposits at all, since that money is in electronic form. Obviously, this would be impossible if this was done physically, as in pre-electronic banks. The difference between lending $100,000 and $10,000,000 of physical objects is the difference between handing someone two handfuls (2.4 kilos) of gold and shipping them a truck laden with 240 kilos of it. The difference between lending those sums electronically is a single keystroke. Accidentally creating millions of dollars' worth of objects is rare. Doing so electronically happens all the time, such as when instead of giving this man the $100,000 overdraft he asked for this bank manager gave him $10,000,000.

Neat, Plausible[edit]

Monetarists assume that the Federal Reserve can influence banks' lending by setting the Fractional Reserve Rate. They assume that this is possible because they assume that banks can't lend without deposits. Ergo they believe that increasing the amount of each deposit that a bank must 'keep' and not lend reduces the amount of lending, that decreasing the Fractional Reserve Limit increases lending, and that using a central bank to directly increase or decrease a bank's reserves will cause it to increase or decrease the creation of new loans respectively. More broadly this belief sits well with their assumption that banks and lending don't affect the economy, or that if they do then it is in a way which never changes and can therefore be safely ignored.
This sounds plausible because Neoclassical economists have a holistic ideological vision in which everyone's economic activities - including those of governments and banks - are just like those of the individual person or household. It seems like common sense that if you cannot physically lend $50 to your friend who has forgotten their wallet, then banks must not be able to lend money unless they already have some. Likewise, it seems like common sense that governments can't spend money unless they take the same amount or more in the form of taxes. While some people are aware that it is possible for governments to spend more than they take, Neoclassicists ensure that these people believe that it will create hyperinflation, which is Satan.
At an academic level, the Fractional Reserve theory has only been able to survive through the ongoing process of purging and no-platforming its critics. Even before the concept was created in the 1970s, it was manifestly apparent that the lending did not require deposits. Yet the inconvenient reality was simply assumed away.[3]

Wrong[edit]

If Fractional Reserve Banking really explained how the actual banking sector worked, there would be a credit crunch every few minutes as the banks waited for people to make deposits. Everyone would pay for almost every ordinary expense with cash, and no-one would ever use credit cards unless they were willing to wait minutes, hours, or even days for the payment to go through.
Instead, banks just create the money they need to get by without paying much - or any - attention to the level which they are nominally supposed to 'keep'. This is why the top-down Quantitative Easing implemented by Japan for two decades and Bernanke+Obama et al. in the Great Recession did not increase lending to businesses and consumers.
“” The quantity of reserve balances itself is not likely to trigger a rapid increase in lending [...] the narrow, textbook money multiplier does not a ppear to be a useful means of assessing the implications of monetary policy for future money growth or bank lending. - Seth Carpenter, Federal Reserve associate director,Money, reserves, and the transmission of monetary policy: does the Money Multiplier exist? p.29
[4] Just as they did in Japan, EU-US banks used the vast majority of the QE funds for the productive (for them) purposes of lending the money one each other with above-inflation rates of interest, where it has sat ever since. In both cases they used a little to buy back their own stocks, buy each other's stocks, buy stocks in other companies, and inflate asset bubbles. Nowhere have they increased lending to businesses or consumers, because the present and predicted future returns on doing so were lower. Of course, Neoclassicists are divided between saying that neither of these examples count because we didn't use allow them to create enough QE money - or that all the things which happened instead of what they predicted must actually be good things because anything which can be done to make money must be good for society, or else it couldn't be done. Classic! [5]

Stopped Clock[edit]

Austrians hate the Franctional Reserve concept not because they understand that it does not apply in reality, but because they have their own equally nutty model of how things 'should be done' instead.
The very thought that a bank may do something other than sit in front of your money and watch it grow mold makes some people foam at the mouth.[6] Many get very quiet if you ask where the interest on their liquid savings accounts would come from then.
The same people often howl that government intervention in the banking system is filthy socialism because it is not their favored economic policy. Safe to say this is often ignoring history, when before there was regulation of fractional reserve banking by the Federal Reserve things were much more exciting for depositors, what with all the constant banking crises and all.

Macroeconomic effects[edit]

In the USA, UK, Australia and much of the developed world all economic growth requires the exponential increase of private debt. This is the ultimate product of the banking system created by the Neoliberal-Neoclassical revolution, which has allowed debts to compound and wealth-extraction from the population to increase. Banking is one of the three principal sectors which maximise the unearned income of plutocrats by extracting value from the wage-earning population, the others being Insurance and Real Estate.
Without a biblical-style cancellation or restructuring of debts, this process will continue until de facto plutonomy and debt-slavery of virtually the entire world population result. [7]


Historical existence[edit]

Fractional Reserve Banking did actually exist in the days when banks kept physical objects such as gold and paper currency which could be withdrawn. In those days it was important for regulators to ensure that banks kept more than the bare minimum of valuable objects to-hand, since the banks naturally wanted to keep as little of them in-house as possible in order to maximise their profits - yet those could be withdrawn, possibly causing a bank run. While many imposed limits on how much could be withdrawn at once in order to limit the amount that they had to keep on hand, lowering the withdrawal amount in a crisis could actually cause more panic and therefore more to be withdrawn as a larger number of depositors showed up demanding their money back. Many small banks in the US went bust as a result of depositors losing confidence in them, which is why the Federal Reserve bank was created to establish Fractional Reserve limits and give gold or cash-money to insolvent banks in an emergency. It also limited the risk that the depositor's insurance (FDIC) would kick in every time one too many people came into the bank asking for cash.

Side-effects[edit]

While banks can't literally print their own money in a system with a central bank, they can increase the money supply. In a system of fiat currency, banks' monetary base (i.e., what is actually in the "vaults") is made up of money which can be supplied by the central bank in time of need. However, when banks make loans above their reserve (which is pretty much always), it adds to the money supply, specifically what economists call "M2" and "M3" (depending on the type of loan), which are considered less "liquid" than the monetary base. Thus, lending can (but not necessarily will) cause demand-pull inflation.
In the world of electronic banking, banks can now create "money" out of thin air, through create accounts. When someone spends these accounts, they are transferred to another bank, then this is lent on an interbank market (FED funds, LIBOR), to give reserves to banks who need it. [8]
It is always possible to still get a run on the bank if too many people demand money in excess of the reserve. A simple analogy is airline seating. Airlines know a few people will cancel, so they overbook flights by selling more tickets than seats. A run on the bank is like everyone showing up to the flight and no cancellations. (Or the plot of Mel Brooks' The Producers, when the play they'd over-sold shares of unexpectedly became a hit.) Bank runs are prevented in modern banking systems by the creation of a lender of last resortWikipedia's W.svg to avoid short-term liquidity shortfalls.
The fractional reserve system itself takes no account of the risks of the loans banks make. If the reserve requirement was set to 100%, interest accumulated in deposits and the generation of loans would be nearly nonexistent. However, no banks would run out of money, as long as they had absolutely no costs. This has traditionally been policy favored mostly by Scrooge McDuck, and Austrians, but has gained currency in certain circles following the 2008 crash, and has been advocated by economists Laurence Kotlikoff, John Kay and John Cochrane as well as the Financial Times' chief economics commentator Martin Wolf, and Iceland look to be heading towards implementing full reserves.[9]

The Conspiracy Theories[edit]

Fractional reserve banking is the subject of numerous conspiracy theories. They usually revolve around or have their roots in anti-Semitism in the form of Jewish banker conspiracies like the Rothschild family controlling the world. This usually ties in to conspiracies about the Federal Reserve as well as gold buggery or sound money. Sometimes the cry of "fractional reserve banking is fraud!" is a cover for some kind of economic woo or scam — usually of the "don't trust banks, put your money in my Ponzi scheme instead" variety. Sometimes these theories are just the result of people failing to understand abstract concepts.

Multiplier effect[edit]

The multiplier effect, or money multiplier, refers to the effects of a bank lending money over its reserve requirements as explained above. By law, banks are required to keep x% (depending on the locale and type of bank) of the total money they lend out in reserve. The resulting amount of money is 1/x multiplied by an original deposited amount, where x is the required reserve ratio in decimal form. For example, a bank is required to have a 20% reserve. Alice deposits her $1000 paycheck into the bank. The bank is able to lend out $800 to Bob, who buys a used car from Charlie, who deposits the $800 into another bank. The bank turns around and lends $640 to Denise, and so on down the line until there is $5000 in the system.
While it may seem a bit like smoke and mirrors to someone unfamiliar with economics, imagine instead of cash it was something with 'obviously' more use such as tools. We all need tools to work, but the vast majority of time we own the tool we aren't using it. So we put the tools in a tool bank, so that others can use it while we are not. If we only need the tools for about 20% of the time, the result is that the bank causes there to be effectively 5 times as many tools in the system. That it's currency instead of tools doesn't change the effect.
The multiplier effect is generally regarded as a simplification in academic and policy making circles. The Bank of England has stated that "while the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality",[10] and the multiplier model "has not featured at all in the recent academic literature". Charles Goodhart, the UK’s pre-eminent monetary economist and former member of the Bank of England's Monetary Policy Comittee has stated that “as long as the Central Bank sets interest rates, as is the generality, the money stock is a dependent, endogenous variable. This is exactly what the heterodox, Post-Keynesians ... have been correctly claiming for decades, and I have been in their party on this.” [11]
In the Post-Keynesian view, the multiplier is an ex-post facto accounting identity (or, in other words, a legal fiction). The reason for this is that a bank can make any loan it deems worthy and then borrow money from either the interbank loan market (a market in which banks lend excess reserves to each other)[12] or the Fed discount window to meet reserve requirements.

Bank capitalization, charters, and the Glass-Steagall Act[edit]

Banking regulation is much stricter than regulation in other industries and the financial sector. To apply for a bank charter, the owners (usually bank holding companies[13]) of the bank's capitalization are required to be debt free. Banks are supposed to be unencumbered rock solid investments.[14] Once the charter is granted the bank then can receive deposits, i.e., a debt owed to depositors encumbered by the bank's capitalization. The combined value of the banks capitalization, along with its ability to lend other peoples money (depositors money) equals the bank's balance sheet.
If a part owner of a bank holding company were to take on private debt, and sold his stake in the bank to satisfy the debt, that could reduce the bank's capitalization, drive down the value of other shareholders stake, curtail the bank's ability to lend, and affect the economic growth and activity in the surrounding neighborhood. Thus holders of bank charters are strictly regulated and supposed to be responsible with a proven track record in managing their own financial affairs.
The Glass-Steagall Act strictly regulated bank's and bank charter owners ability to use bank assets (i.e., a bank's capitalization, depositor's money, and earnings from its capitalization and depositors money). Under Glass-Steagall banks were limited to collecting interest off of lending depositors money (which a portion was paid back to depositors) or brokering deals -- bringing buyer and seller together and making a fee off the transaction without using the bank's own cash. Repealing Glass-Steagall opened the door to proprietary trading -- removing the heretofore strict requirements of banks to only invest or engage in the most conservative activities, and allowing them to purchase with bank stock and earnings, riskier assets with potentially more lucrative return, such as sub-prime mortgages[15] and insurance companies loaded with potential risk and liabilities.
The Volcker Rule, named after former Federal Reserve Chairman Paul Volcker and part of the Dodd-Frank Fin Reg bill aimed at Wall Street reform, is an effort to allow the Federal Reserve stricter oversight of bank holding companies ownership and activities, which is difficult due to confidentiality agreements and privacy rights.[16]
The United States is the only country in the world to have ever imposed the segregation of consumer banking and investment banking which existed under Glass-Steagall.

External links[edit]

See also[edit]

Icon fun.svg For those of you in the mood, RationalWiki has a fun article about Fractional-reserve banking.
Economics Tautology

References[edit]

  1. Jump up ↑ Steve Keen, Debunking Economics - The Naked Emperor Dethroned? p.308
  2. Jump up ↑ Martinez, Raoul, Creating Freedom: Power, Control and the Fight for Our Future (Edinburgh, 2016), accessed at https://books.google.com.au/books?id=Nv2pCwAAQBAJ&pg=PT314&lpg=PT314&dq=%22Banks+do+not,+as+too+many+textbooks+still+suggest,+take+deposits+of+existing+money+from+savers%22&source=bl&ots=PCrJyDmPc4&sig=6JFaITQbHpXBZK5cOh2ifMTI1us&hl=en&sa=X&ved=0ahUKEwi18tG5-PHWAhVCmpQKHbz8CgIQ6AEILjAB#v=onepage&q=%22Banks%20do%20not%2C%20as%20too%20many%20textbooks%20still%20suggest%2C%20take%20deposits%20of%20existing%20money%20from%20savers%22&f=false
  3. Jump up ↑ Keen, Steve, Debunking Economics – The Naked Emperor Dethroned?, second edition, (New York, 2011) p.307-312
  4. Jump up ↑ printed in Keen, Steve, Debunking Economics – The Naked Emperor Dethroned?, second edition, (New York, 2011) p.313
  5. Jump up ↑ Hudson, Michael, Killing the Host: How Financial Parasites and Debt Destroy the Global Economy (Baskerville, 2015) pp.82-84
  6. Jump up ↑ Those guys are really against fractional reserve banking? I really didn't expect that these guys want to destroy capitalism.
  7. Jump up ↑ Hudson, Michael, Killing the Host: How Financial Parasites and Debt Destroy the Global Economy (Baskerville, 2015) p.158
  8. Jump up ↑ Commercial banks by far create more new money daily by interbank lendingWikipedia's W.svg than the Federal Reserve does. Depositing loan proceeds drawn on one bank with another bank creates new money (the same money appears as an asset on both bank's ledgers). The daily reconcilation of accounts between banks - cashing checks drawn on each other's accounts, and banks with surplus deposits helping a bank with a lot of loan activity in one day causing it to fall below reserve requirements, also affects interbank lending, See here Note 7.
  9. Jump up ↑ http://www.ft.com/cms/s/0/6773cec8-deaf-11e4-8a01-00144feab7de.html#axzz3qD2Xwdmo
  10. Jump up ↑ http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
  11. Jump up ↑ http://www.bankofengland.co.uk/research/Documents/workingpapers/2015/wp529.pdf
  12. Jump up ↑ In Great Britain interbank borrowing is done at the LIBOR rate. In the United States, commercial interbank borrowing to meet reserve requirements is done at the Federal Funds rate, also known as bankers cost of funds.
  13. Jump up ↑ Defintion: bank holding company
  14. Jump up ↑ Bank Holding Company Act. Capital Adequacy Guidelines:Risk-Based Measure. www.fdic.gov
  15. Jump up ↑ Regulation Y Revised, Federal Reserve Bank of San Fransisco.
  16. Jump up ↑ The "Volcker Rule": Proposals to Limit "Speculative" Proprietary Trading by Banks, Congressional Research Service, June 22, 2010.
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Wednesday, 20 March 2013

United States Notes, and the Greenbacks

 
 
It is claimed that Abraham Lincoln issued Greenbacks which were United State Notes that largely financed the success of the American Civil War rather than relying on borrowing from banks, and similiar sources . RS
 
 
 
 
 
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Large-sized Series of 1880 United States Notes; the $20 note displays Alexander Hamilton and a red scalloped seal, and the $10 Daniel Webster and a large red spiked seal
A United States Note, also known as a Legal Tender Note, is a type of paper money that was issued from 1862 to 1971 in the U.S. Having been current for over 100 years, they were issued for longer than any other form of U.S. paper money. They were known popularly as "greenbacks" in their heyday, a name inherited from the Demand Notes that they replaced in 1862. Often called Legal Tender Notes, they were called United States Notes by the First Legal Tender Act, which authorized them as a form of fiat currency. During the 1860s the so-called second obligation on the reverse of the notes stated:[1]
This Note is Legal Tender for All Debts Public and Private Except Duties On Imports And Interest On The Public Debt; And Is Redeemable In Payment Of All Loans Made To The United States.
They were originally issued directly into circulation by the U.S. Treasury to pay expenses incurred by the Union during the American Civil War. Over the next century, the legislation governing these notes was modified many times and numerous versions have been issued by the Treasury.
United States Notes that were issued in the large-size format, before 1929, differ dramatically in appearance when compared to modern American currency, but those issued in the small-size format, starting in 1929, are very similar to contemporary Federal Reserve Notes with the highly visible distinction of having red U.S. Treasury Seals and serial numbers in place of green ones.
Existing United States Notes remain valid currency in the United States. However, since no United States Notes have been issued since January 1971, they are vanishingly rare in circulation.

Contents

 [hide] 

[edit] History

See also: Union (American Civil War)#Economy

[edit] Demand Notes


Comparison of a $5 Demand Note (upper image) and an 1862 issue $5 United States Note (lower image). Note the removal of the words "On Demand" and of the phrase "Receivable in Payment of All Public Dues". Also note the Treasury Seal added to the United States Note.
During 1861, the opening year of the American Civil War, the expenses incurred by the Union Government far outstripped its limited revenues from taxation, and borrowing was the main vehicle for financing the war. The Act of July 17, 1861[2] authorized Secretary of the Treasury Salmon P. Chase to raise money via the issuance of $50,000,000 in Treasury Notes payable on demand.[3] These Demand Notes were paid out to creditors directly and used to meet the payroll of soldiers in the field. While issued within the legal framework of Treasury Note Debt, the Demand Notes were intended to circulate as currency and were of the same size as and, in appearance, closely resembled banknotes.[4] In December 1861, economic conditions deteriorated and a suspension of specie payment led the government to cease redeeming the Demand Notes in coin.

[edit] The Legal Tender Acts

The beginning of 1862 found the Union's expenses mounting, and the government was having trouble funding the escalating war. U.S. Demand Notes—which were used, among other things, to pay Union soldiers—were unredeemable, and the value of the notes began to deteriorate. On January 16, 1862, in a private meeting with President Lincoln, Edmund Dick Taylor advised him to issue greenbacks as legal tender.[5][6] Congressman and Buffalo banker Elbridge G. Spaulding prepared a bill, based on the Free Banking Law of New York, that eventually became the National Banking Act of 1863.[7] Recognizing, however, that his proposal would take many months to pass Congress, in early February Spaulding introduced another bill to permit the U.S. Treasury to issue $150 million in notes as legal tender.[8] This caused tremendous controversy in Congress, as hitherto the Constitution had been interpreted as not granting the government the power to issue a paper currency. "The bill before us is a war measure, a measure of necessity, and not of choice," Spaulding argued before the House, adding, "These are extraordinary times, and extraordinary measures must be resorted to in order to save our Government, and preserve our nationality." Spaulding justified the action as a "necessary means of carrying into execution the powers granted in the Constitution 'to raise and support armies,' and 'to provide and maintain a navy.'”[9] Despite strong opposition, President Lincoln signed the First Legal Tender Act,[10] enacted February 25, 1862, into law, authorizing the issuance of United States Notes as a legal tender—the paper currency soon to be known as "greenbacks".
Initially, the emission was limited to $150,000,000 total face value between the new Legal Tender Notes and the existing Demand Notes. The Act also called for the new notes to be used to replace the Demand Notes as soon as practical. The Demand Notes had been issued in denominations of $5, $10, and $20, and these were replaced by United States Notes nearly identical in appearance on the obverse. In addition, notes of entirely new design were introduced in denominations of $50, $100, $500 and $1000. The Demand Notes' printed promise of payment "On Demand" was removed and the statement "This Note is a Legal Tender" was added.

A political cartoon from the 1864 election depicting Secretary Fessenden of the Lincoln administration running "Chase's Mill" at left to flood the country with Greenbacks
Legal tender status guaranteed that creditors would have to accept the notes despite the fact that they were not backed by gold, bank deposits, or government reserves, and bore no interest. However, the First Legal Tender Act did not make the notes an unlimited legal tender as they could not be used by merchants to pay customs duties on imports and could not be used by the government to pay interest on its bonds. The Act did provide that the notes be receivable by the government for short term deposits at 5% interest, and for the purchase of 6% interest 20-year bonds at par. The rationale for these terms was that the Union government would preserve its credit-worthiness by supporting the value of its bonds by paying their interest in gold. Early in the war, customs duties were a large part of government tax revenue and by making these payable in gold, the government would generate the coin necessary to make the interest payments on the bonds. Lastly, by making the bonds available for purchase at par in United States Notes, the value of the latter would be supported as well.[3] The limitations to the legal tender status were quite controversial. Thaddeus Stevens, the Chairman of the House of Representatives Committee of Ways and Means, which had authored an earlier version of the Legal Tender Act that would have made United States Notes a legal tender for all debts, denounced the exceptions, calling the new bill "mischievous" because it made United States Notes an intentionally depreciated currency for the masses, while the banks who loaned to the government got "sound money" in gold. This controversy would continue until the removal of the exceptions in 1933.
In the First Legal Tender Act, Congress limited the Treasury's emission of United States Notes to $150,000,000; however, by 1863, the Second Legal Tender Act,[11] enacted July 11, 1862, a Joint Resolution of Congress,[12] and the Third Legal Tender Act,[13] enacted March 3, 1863, had expanded the limit to $450,000,000, the option to exchange the notes for United States bonds at par had been revoked, and notes of $1 and $2 denominations had been introduced as the appearance of fiat currency had driven even silver coinage out of circulation. As a result of this inflation, the greenback went on to trade at a substantial discount from gold, which prompted Congress to pass the short-lived Anti-gold futures act of 1864, which was soon repealed after it seemed to accelerate the decline of the greenback.
The largest amount of greenbacks outstanding at any one time was calculated as $447,300,203.10.[14] The Union's reliance on expanding the circulation of greenbacks eventually ended with the emission of Interest Bearing and Compound Interest Treasury Notes, and the passage of the National Banking Act. However, the end of the war found the greenbacks trading for only roughly half of their nominal value in gold.[3]

[edit] Post Civil War

At the end of the Civil War, some economists, such as Henry Charles Carey, argued for building on the precedent of non-debt-based fiat money and making the greenback system permanent.[15] However, Secretary of the Treasury McCulloch argued that the Legal Tender Acts had been war measures, and that the United States should soon reverse them and return to the gold standard. The House of Representatives voted overwhelmingly to endorse the Secretary's view.[16] With an eventual return to gold convertibility in mind, the Funding Act of April 12, 1866[17] was passed, authorizing McCulloch to retire $10 million of the Greenbacks within six months and up to $4 million per month thereafter. This he proceeded to do until only $356,000,000 were outstanding in February 1868. By this point, the wartime economic boom was over, the crop harvest was poor, and a panic in Great Britain caused a recession and a sharp drop in prices in the United States.[18] The contraction of the money supply was blamed for the deflationary effects, and led debtors to successfully agitate for a halt to the notes' retirement.[19]
In the early 1870s, Treasury Secretaries George S. Boutwell and William Adams Richardson maintained that, though Congress had mandated $356,000,000 as the minimum Greenback circulation, the old Civil War statutes still authorized a maximum of $400,000,000[20] - and thus they had at their discretion a "reserve" of $44,000,000. While the Senate Finance Committee under John Sherman disagreed, being of the opinion that the $356,000,000 was a maximum as well as a minimum, no legislation was passed to assert the Committee's opinion. Starting in 1872, Boutwell and Richardson used the "reserve" to counteract seasonal demands for currency, and eventually expanded the circulation of the Greenbacks to $382,000,000 in response to the Panic of 1873.[21]
In June 1874, Congress officially capped the Greenback circulation at $382,000,000, and in January 1875, passed the Specie Payment Resumption Act, which authorized a contraction in the circulation of Greenbacks towards a revised limit of $300,000,000, and required the government to redeem them for gold, on demand, after 1 January 1879. As a result, the currency strengthened and by April 1876, the notes were on par with silver coins which then began to re-emerge into circulation.[22] On May 31, 1878, the contraction in the circulation was halted at $346,681,016 - a level which would be maintained for almost 100 years afterwards.[23] While $346,681,016 was a significant figure at the time, it is now a very small fraction of the total currency in circulation in the United States. The year 1879 found Sherman, now Secretary of the Treasury, in possession of sufficient specie to redeem notes as requested, but as this brought the value of the greenbacks into parity with gold for the first time since the Specie Suspension of December 1861, the public voluntarily accepted the greenbacks as part of the circulating medium.[16]

Series of 1901 $10 Legal Tender depicting military explorers Meriwether Lewis, William Clark, and an American bison.
While the United States Notes had been used as a form of debt issuance during the Civil War, afterwards they were used as a way of moderately influencing the money supply by the federal government - such as through the actions of Boutwell and Richardson. During the Panic of 1907, President Theodore Roosevelt attempted to increase liquidity in the markets by authorizing the Treasury to issue more Greenbacks, but the Aldrich-Vreeland Act provided for the needed flexibility in the National Bank Note supply instead. Eventually, the perceived need for an elastic currency was addressed with the Federal Reserve Notes authorized by the Federal Reserve Act, and pressure to alter the circulating quantity of United States Notes subsided.
Soon after private ownership of gold was banned in 1933, all of the remaining types of circulating currency, silver certificates, Federal Reserve Notes, and United States Notes, were redeemable by individuals only for silver. Eventually, even silver redemption stopped in 1965-68, during a time in which all U.S. currency (both coins and paper currency) was changed to fiat currency. At this point for the general public, there was little to distinguish United States Notes from Federal Reserve Notes. As a result, the public circulation of United States Notes, which was then mainly in the form of $5 bills, was replaced with $5 Federal Reserve Notes, and the stock of United States Notes was mostly converted into $100 bills, which spent most of their time in bank vaults. No more United States Notes were put into circulation after January 21, 1971.[24] In September 1994 the Riegle Improvement Act released the Treasury from its long-standing obligation to keep the notes in circulation and finally, in 1996, the Treasury announced that its stock of $100 United States Notes had been destroyed.[25]

[edit] Comparison to Federal Reserve Notes

The United States Note was a national currency whereas Federal Reserve Notes are issued by the quasi-federal Federal Reserve System.[26] Both have been legal tender since the gold recall of 1933. Both have been used in circulation as money in the same way. However, the issuing authority for them came from different statutes.[24] United States Notes were created as fiat currency, in that the government has never categorically guaranteed to redeem them for precious metal - even though at times, such as after the specie resumption of 1879, federal officials were authorized to do so if requested. The difference between a United States Note and a Federal Reserve Note is that a United States Note represented a "bill of credit" and was inserted by the Treasury directly into circulation free of interest. Federal Reserve Notes are backed by debt purchased by the Federal Reserve, and thus generate seigniorage, or interest, for the Federal Reserve System, which serves as a lending parent to the Treasury and the public.
As the debt purchased by the Federal Reserve System to back its notes consists primarily of Treasury and Government-sponsored enterprise debt,[27] and because the seigniorage is largely remitted back to the Treasury as "interest on Federal Reserve Notes", the economics to the Treasury are comparable to issuing United States Notes. This stands in contrast to National Bank Notes which allowed the issuing banks to privately retain the seigniorage as profit.

[edit] Characteristics


The first small size $1 United States Note issued (Smithsonian Institution).

The first small size $2 United States Note issued (Smithsonian Institution).

The first small size $5 United States Note issued (Smithsonian Institution).
Like all U.S. currency, United States Notes were produced in a large sized format until 1929, at which point the notes' sizes were reduced to the small-size format of the present day.
The original large-sized Civil War issues were dated 1862 and 1863, and issued in denominations of $1, $2, $5, $10, $20, $50, $100, $500 and $1000.[28] The United States Notes were dramatically redesigned for the Series of 1869, the so-called Rainbow Notes. The notes were again redesigned in the Series of 1874, 1875 and 1878. The Series of 1878 included, for the first and last time, notes of $5,000 and $10,000 denominations. The final across-the-board redesign of the large-sized notes was the Series of 1880. Individual denominations were redesigned in 1901, 1907, 1917 and 1923.
On small-sized United States Notes, the U.S. Treasury Seal and the serial numbers are printed in red (contrasting with Federal Reserve Notes, where they usually appear in green). By the time the small-size format was adopted, the Federal Reserve System was already in place and there was limited need for United States Notes. They were mainly issued in $2 and $5 denominations in the Series years of 1928, 1953, and 1963. There was a limited issue of $1 notes in the Series of 1928, and an issue of $100 notes in the Series year of 1966, mainly to satisfy legacy legal requirements of maintaining the mandated quantity in circulation.
Section 5119(b)(2) of Title 31, United States Code, was amended by the Riegle Community Development and Regulatory Improvement Act of 1994 (Public Law 103-325) to read as follows: "The Secretary shall not be required to reissue United States currency notes upon redemption." This does not change the legal tender status of United States Notes nor does it require a recall of those notes already in circulation. This provision means that United States Notes are to be cancelled and destroyed but not reissued. This will eventually result in a decrease in the amount of these notes outstanding.[29]

[edit] Public Debt of the United States

As of December 2012, the U.S. Treasury calculates that $239 million in United States notes are in circulation, and excludes this amount from the statutory debt limit of the United States. This amount excludes $25 million in United States Notes issued prior to July 1, 1929, determined pursuant to Act of June 30, 1961, 31 U.S.C. 5119, to have been destroyed or irretrievably lost.[30]

[edit] Politics and controversy

The concept of replacing precious metals with fiat paper as the medium of exchange was contentious and attracted attention.
The United States Congress had enacted the Legal Tender Acts during the U.S. Civil War when southern Democrats were absent from the Congress, and thus their Jacksonian hard money views were underrepresented. After the war, the Supreme Court ruled on the Legal Tender Cases to determine the constitutionality of the use of greenbacks. The 1870 case Hepburn v. Griswold found unconstitutional the use of greenbacks when applied to debts established prior to the First Legal Tender Act as the five Democrats on the Court, Nelson, Grier, Clifford, Field, and Chase, ruled against the Civil War legislation in a 5-3 decision. Secretary Chase had become Chief Justice of the United States and a Democrat, and spearheaded the decision invalidating his own actions during the war. However, Grier retired from the Court, and President Grant appointed two new Republicans, Strong and Bradley, who joined the three sitting Republicans, Swayne, Miller, and Davis, to reverse Hepburn, 5-4, in the 1871 cases Knox v. Lee and Parker v. Davis. In 1884, the Court, controlled 8-1 by Republicans, granted the federal government very broad power to issue Legal Tender paper through the case Juilliard v. Greenman, with only the lone remaining Democrat, Field, dissenting.[21]
The states in the far west stayed loyal to the Union, but also had hard money sympathies. During the specie suspension from 1862 to 1878 western states used the gold dollar as a unit of account whenever possible and accepted greenbacks at a discount wherever they could.[3] The preferred forms of paper money were gold certificates and National Gold Bank Notes, the latter having been created specifically to address the desire for hard money in California.
During the 1870s and 1880s, the Greenback Party existed for the primary purpose of advocating an increased circulation of United States Notes as a way of creating inflation according to the quantity theory of money. However, as the 1870s unfolded, the market price of silver fell with respect to gold, and inflationists found a new cause in the Free Silver movement. Opposition to the resumption of specie convertibility of the Greenbacks in 1879 was accordingly muted.

[edit] See also

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[edit] Footnotes

  1. ^ Friedberg, Arthur L. and Ira S., 2006, Paper Money of the United States, 18th Edition, Clifton, NJ, The Coin & Currency Institute, Inc. ISBN 0-87184-518-0
  2. ^ United States Congress. Act of July, 17 1861 Chapter Ⅴ. Washington D.C.: 1861
  3. ^ a b c d Mitchell, Wesley Clair, "A History of the Greenbacks With Special Reference To the Economic Consequences of Their Issue 1862-65", University of Chicago, Chicago, 1903.
  4. ^ Chittenden, L.E., Recollections of President Lincoln and His Administration, Harper & Brothers, New York, 1891.
  5. ^ Congressional Serial Set, Issue 2599, Volume 2. Report No. 380, U.S. G.P.O., 1888.
  6. ^ Abraham Lincoln's pen and voice, p. 404. Abraham Lincoln, George Mandeville Van Buren, 1890.
  7. ^ Heidler, D.S. & Heidler, J.T. (2000). Encyclopedia of the American Civil War: a political, social, and military history (p. 1168). New York, NY: W.W. Norton.
  8. ^ McPherson, J.M. (1988). Battle cry of freedom: the Civil War era (p.445). New York, NY: Oxford University Press.
  9. ^ Spaulding, E.G. (1869). History of the legal tender paper money issued during the great rebellion (p.29). Buffalo, NY: Express Printing.
  10. ^ ch. 33, 12 Stat. 345
  11. ^ ch. 142, 12 Stat. 532
  12. ^ United States Congress. Resolution of January 17, 1863, No. 9. Washington D.C.: 1863
  13. ^ ch. 73, 12 Stat. 709
  14. ^ Backus, Charles K., "The Contraction of the Currency", The Honest Money League of the Northwest, Chicago, Ill., 1878.
  15. ^ Carey, Henry Charles (March 1865) The Way to Outdo England Without Fighting Her
  16. ^ a b United States Notes, John Joseph Lalor, "Cyclopaedia of Political Science, Political Economy, and of the Political History of the United States", Rand McNally & Co, Chicago, 1881.
  17. ^ United States Congress. Act of April 12, 1866 Chapter XXXIII. Washington D.C.: 1866
  18. ^ Studenski, Paul; Krooss, Hermand Edward (1952). Financial History of the United States, New York, NY: McGraw-Hill. ISBN 1-58798-175-0.
  19. ^ The Greenback Question. Retrieved May 30, 2009.
  20. ^ While the three Legal Tender Acts had authorized $450,000,000 of notes, the Second Legal Tender Act, in taking the total from $150,000,000 to $300,000,000 had reserved $50,000,000 of the increase for the purpose of redeeming balances in a temporary deposit program. The Act of June 30, 1864, reiterated this limitation, and as the temporary loan program had ceased to exist, only $400,000,000 of the $450,000,000 ceiling were available.
  21. ^ a b Timberlake, Richard H.(1993). Monetary Policy in the United States: An Intellectual and Institutional History, Chicago, IL: University of Chicago Press. ISBN 978-0-226-80384-5.
  22. ^ Bowers, Q. David; David Sundman (2006). 100 GREATEST AMERICAN CURRENCY NOTES, Atlanta, Georgia: Whitman Publishing. ISBN 0-7948-2006-9.
  23. ^ The National Balance Sheet; It Includes $71,000,000 of Debits Which Might Well Be Dropped New York Times May 24, 1903, Sunday
  24. ^ a b U.S. Treasury - FAQ: Legal Tender Status
  25. ^ Hessler, Gene and Chambliss, Carlson (2006). The Comprehensive Catalog of U.S. Paper Money, 7th edition, Port Clinton, Ohio: BNR Press ISBN 0-931960-66-5.
  26. ^ "President John F.Kennedy, The Federal Reserve, and Executive Order 11110". The Final Call 15 (6). January 17, 1996. http://www.john-f-kennedy.net/executiveorder11110.htm.
  27. ^ Board of Governors of the Federal Reserve System, Financial Statements of the Federal Reserve System, Combined Federal Reserve Banks as of December 31, 2011
  28. ^ Chronology of Large-Size Notes Retrieved June 6, 2009.
  29. ^ http://www.bep.treas.gov/historicallegislation.html
  30. ^ "Monthly Statement of the Public Debt of the United States". United States Treasury Department. 2012-12-31. http://www.treasurydirect.gov/govt/reports/pd/mspd/2012/opdm122012.pdf. Retrieved 2013-01-08.

[edit] Further reading

[edit] External links



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